The Ghosts of Economics Past

In Charles Dicken's great novel "A Christmas Carol," the soulless businessman Ebeneezer Scrooge is tormented by a visit from the Spirit of Christmas Past. Today, economists are similarly troubled by unwanted ghosts, as they ponder the reappearance of economic ills long thought buried and dead.

From Stephen Roach at Morgan Stanley to Paul Krugman at Princeton, to the Governors of the US Federal Reserve and the senior staff at the European Central Bank, to almost everyone in Japan, economists all over the world are worrying about deflation. Their thoughts retrace the economic thinking of over fifty years ago, a time when economists concluded that the thing to do with deflation was to avoid it like the plague.

Back in 1933 Irving Fisher --Milton Friedman's predecessor atop America's monetarist school of economists-- announced that governments could prevent deep depressions by avoiding deflation. Deflation --a steady ongoing decline in prices-- gave businesses and consumers powerful incentives to cut spending and hoard cash. It reduced the ability of businesses and banks to service their debt, and might trigger a chain of big bankruptcies that would destroy confidence in the financial system, providing further incentives to hoard.

Such strong incentives to hoard rather than spend can keep demand low and falling, and unemployment high and rising, for a much longer time than even the most laissez-faire-oriented politician or economist had ever dared contemplate. Hence the Keynesian solution: use monetary policy (lower interest rates) and fiscal policy (expanded government spending and reduced taxes) to keep the economy from ever approaching the precipice where deflation becomes possible.