Deflation or Inflation - Guide to Picking Poisons

America's Greatest Fear - Deflation

Deflation is a decline in the price level of goods and services.  Generally, we cheer when the price of goods (groceries, gas, cars) decline.  As for policy makers, they fear deflation as if it was the great plague.  In fact, no country champions the cause against deflation more strongly than the U.S.

To understand the paradigm of America's decision makers, we must turn to a lesson in history.  The worst recession in recent memory, the Great Depression of the 1930's, was a deflationary period.  During such episodes, the economy could experience deflationary spirals, whereby declining prices induce the expectation of ever-lower prices in the future, hence creating a feedback-loop which results in uncontrolled price declines.

In addition, policy makers may run into what is known as a liquidity trap, whereby their traditional tools of monetary policy become exhausted.  This exact problem was addressed by current Fed Chairman Ben Bernanke, in the now famous speech Deflation: Making Sure "It" Doesn't Happen Here.  Chairman Bernanke reassured congress that through the 'helicopter drop' of money, the Fed would be able to successfully combat deflation.  With regard to this assertion, I am inclined to agree with Chairman Bernanke; I am also deeply concerned about the potential ramifications of such reckless monetary policy.  My fears are echoed by our neighbors across the Atlantic.


Germany's Worst Nightmare - Inflation

Just as America's paradigms were influenced by its history, so too were those of the German people.  Though the inflation in the Weimar Republic, post WWI Germany, was nearly 100 years ago, the people have not forgotten the horror:

Inflation is an increase in the general price level of goods and services.  Hyper-inflation is the runaway effects of such a price increase.  From the years 1918 to 1923, what used to cost 1 Mark increased in price, until the same good could not be purchased for less than 1 Trillion Marks.  To personalize this increase, imagine a 1 liter bottle of Coke costing approximately $1,000,000,000,000 dollars.  It sounds ridiculous, but sadly, it was a part of German history (Germans were not alone in this... hyperinflation dates back to as far as the time of the Romans... likely since the invention of money itself ).

All I'm saying is...

I believe our policy makers are influenced greatly by the events of the country's history.  To that extent, the strong aversion to deflationary periods is understandable.

However, the lack of respect for counterbalancing forces could force us to learn some harsh lessons in the near future.  Perhaps we should turn to our German neighbors to strike a more balanced view.