ECONOMICS SATURDAY

Dangers of Deflation

Though talk of deflation fills the air, most of that talk is subtly but significantly off point. The immediate danger isn't deflation per se; it's the risk that the world's major economies will find themselves trapped in an economic quagmire. Deflation can be both a symptom of an economy sinking into the muck, and a reason why it sinks even deeper, but it's usually a lagging indicator. The crucial question is whether we'll stumble into the swamp in the first place — and the risks look uncomfortably high.

The particular type of quagmire to worry about has a name: liquidity trap. As the I.M.F. report explains, the most important reason to fear deflation is that it can push an economy into a liquidity trap, or deepen the distress of an economy already caught in the trap.

Here's how it works, in theory. Ordinarily, deflation — a general fall in the level of prices — is easy to fight. All the central bank (in our case, the Federal Reserve) has to do is print more money, and put it in the hands of banks. With more cash in hand, banks make more loans, interest rates fall, the economy perks up and the price level stops falling.

But what if the economy is in such a deep malaise that pushing interest rates all the way to zero isn't enough to get the economy back to full employment? Then you're in a liquidity trap: additional cash pumped into the economy — added liquidity — sits idle, because there's no point in lending money out if you don't receive any reward. And monetary policy loses its effectiveness.

For New York Times Paul Krugman essay on Bush's ecomomy, click here (includes a harmless, but annoying registration procedure).

Thanks to Eschaton.

George W. Bush has the worst economic record of any president since Herbert Hoover

Likewise, no one holds Bush accountable for the dot-com bust or the shock of September 11. His problems are that he's enacted and proposed nothing that would arrest the current slide, and that his policies have actually worsened it.

More precisely, his policy has actually worsened it. For it is the distinctive feature of the Bush presidency that there is but one economic policy come boom or bust, fire or flood. That, of course, is tax cuts, preponderantly for the rich. As a candidate in 2000, Bush argued for tax cuts because the government was actually running a surplus, and it was a more productive use of funds to return that money to taxpayers. Then the bubble burst, the surplus turned to deficit and those same tax cuts were repackaged as an economic stimulus. The $1.6 trillion tax cut of 2001 was so advertised, though it didn't really kick in for the better part of the decade, and most of it was targeted to the wealthy—the class of Americans least likely to spend it. Since it was enacted, it has stimulated the economy to the tune of 1.7 million jobs lost.

Click here.

Thanks to This Modern World.

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