4

The Price Paradox

LONDON – In 1923, John Maynard Keynes addressed a fundamental economic question that remains valid today. “[I]nflation is unjust and deflation is inexpedient," he wrote. “Of the two perhaps deflation is…the worse; because it is worse…to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other."

The logic of the argument seems irrefutable. Because many contracts are “sticky" (that is, not easily revised) in monetary terms, inflation and deflation would both inflict damage on the economy. Rising prices reduce the value of savings and pensions, while falling prices reduce profit expectations, encourage hoarding, and increase the real burden of debt.

Keynes's dictum has become the ruling wisdom of monetary policy (one of his few to survive). Governments, according to the conventional wisdom, should aim for stable prices, with a slight bias toward inflation to stimulate the “animal spirits" of businessmen and shoppers.

In the ten years prior to the 2008 financial crisis, independent central banks set an inflation target of about 2%, in order to provide economies with a price-stability “anchor." There should be no expectation that prices would be allowed to deviate, except temporarily, from the target. Uncertainty relating to the future course of prices would be eliminated from business calculations.