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Deflation: The Good and the Bad


West Virginia economist George Selgin has an article posted on The American Conservative website on deflation.  He analyzes the effects and types of deflation in a way that’s both easy to read and understand.  Some of the recent worries over deflation have been based on the “sticky” wage argument.  Selgin responds,

Many experts insist, for example, that to allow any deflation is to risk putting people out of work because “sticky” wages and salaries will fail to keep pace with falling prices, causing rising labor costs to put a squeeze on employers. That’s a fine argument against bad deflation. But if output prices only decline when goods are being produced more efficiently, there’s no need for wages and salaries to fall along with them. On the contrary, productivity gains mean higher real wages and salaries in equilibrium, and the easiest way to achieve that equilibrium is to leave wages alone while letting the price level fall. When output prices are held up instead, money wages and salaries have to rise.

So, if the real value of money is rising at the same rate that output is increasing, then the “sticky” wage argument for why deflation is bad falls apart.  Check out the article for some more details on the causes of business cycles and what he calls “bad deflation.”

Thanks Steve Horwitz, at The Austrian Economists blog, for pointing article out.