lifestyle leader

In August we pointed out that summertime worries over inflation were probably overstated. Since then, a collapse in commodity markets and consumer spending has vindicated this view - so much so that the new worry is deflation. Deflation is by most accounts worse than inflation because of the difficulty in reversing the trend. First, a backgrounder:

Deflation is "A general decline in prices, often caused by a reduction in the supply of money or credit.... Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflation, [central banks] can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation."

The trouble is, central banks have been attempting to increase the money supply by lowering interest rates with less-than-stellar success. Besides, there are inherent limits to monetary policy - limits which seem to be approaching quickly.

So what to do? John Kemp argues forcefully that the best way to deal with deflation is to stop trying to fix it. Que? Based on his reading of previous depressions, deflation is the symptom of a severe decline in the business cycle, not the cause. The full article is very interesting (so is this one), but the conclusion reads as follows:

Rather than worrying about a modest decline in the price level, policy needs to focus on guaranteeing households and businesses against the worst aspects of the downturn to minimize the decline in spending and investment. Policies that create demand and jobs, while limiting foreclosures and bankruptcies, rather than fight the deflation chimera or worry about falling asset values are now the urgent priority.

That means fiscal stimulus! But rather than rely upon the government for everything, Dr. Boli recommends that consumers also do their part (via Megan McArdle):