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Why Government Fights Deflation Like a Rabid Dog

Paul Krugman's piece in yesterday's New York Times got me thinking about why governments everywhere are so rabidly fighting the deflationary impulses around us. For consumers and businesses which have managed their balance sheets prudently, deflation is a positive force, a simple reflection of advances in technology and productivity which are the natural product of capitalist endeavor. Government fights it to the very last ounce of its being, however, because deflation attacks its core function (or at least what liberals believe is its core function) of maintaining nominal incomes.

Krugman states:
The problem is that deflation — falling wages and prices — is always and everywhere a deeply painful process. It invariably involves a prolonged slump with high unemployment. And it also aggravates debt problems, both public and private, because incomes fall while the debt burden doesn’t.

Deflation can certainly be (even a fatal) problem for severely indebted businesses, but in general businesses just deal with it. They have no other choice. Private entities respond to deflation as a matter of survival, typically quickly, sometimes overdoing it (see the huge inventory swing). For government, on the other hand, deflation reveals the inefficiencies and cronyism of government spending. Government uses the powers of taxation and the printing press to drag its feet, kick the can, delay, delay, delay. Of course, these problems are made worse when some members of the private sector are able to foist their debts on the taxpayer, as we saw with the bailouts. But the core of the matter is that the incentives for each entity (government vs. business) are exactly opposite. The goal for business is profit, which allows continued existence, and, perhaps, growth. The goal in the case of government is maintaining nominal incomes.


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