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The topic of deflation is starting to be mentioned on a number of threads. I think the time has come for an SI thread dedicated to the exploration and discussion of the concept and its potential ramifications for investors.
"CAN DEFLATION BE PREVENTED?
This week's cover story in The Economist makes it more or less official. Deflation, not inflation, is now the greatest concern for the world economy. Over the past year, producer prices have fallen throughout the advanced world; consumer prices have been falling for the last 6 months in France and Germany; in Japan wages have actually fallen 4 percent over the past year. Until the recent crisis prices were falling in Brazil; they continue to fall in China and Hong Kong; they will probably soon be falling in a number of other developing countries.
So far, none of these price declines looks anything like the massive deflation that accompanied the Great Depression. But the appearance of deflation as a widespread problem is disturbing, not only because of its immediate economic implications, but because until recently most economists - myself included - regarded sustained deflation as a fundamentally implausible prospect, something that should not be a concern.
The point is that deflation should - or so we thought - be easy to prevent: just print more money. And printing money is normally a pleasant experience for governments. In fact, the idea that governments have a hard time keeping their hands off the printing press has long been a staple of political economy; dozens of theoretical papers have argued that the temptation to engage in excessive money creation causes an inherent inflationary bias in fiat-money economies. It is largely to combat that presumed bias that most of the world has accepted the notion that monetary policy should be conducted by an independent central bank, insulated from political influence - and has written into the charters of those central banks that they should seek price stability as their main, often only, goal.
Yet here we are, with deflation turning out to be a serious problem after all - and with policymakers finding that it is not as easy either to prevent or to reverse as we all thought.
How can this be happening? What does it imply for policy? The purpose of this note is to argue that more or less conventional economic theory actually does suggest some answers to these questions - but that these answers fly in the face of conventional policy wisdom. And because the answers are so hard to accept, deflation is indeed a real risk..."
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