Mild Deflation?
Jude Wanniski
June 22, 1999


Memo To: George Selgin, U.of Georgia economist
From: Jude Wanniski
Re: Your Plea for (Mild) Deflation

You have put a lot of thought and work into your "Case for a Falling Price Level in a Growing Economy," which is excerpted in the May/June CATO Policy Report. The idea is interesting in that we have been in a deflation for the past two years, since the price of gold began its decline from the $385 level to its current $260. I'm really not happy with the deflation, though, even though it has the advantage of causing a reverse "bracket creep" down the progressive tax ladder. This is because it has caused terribly unfair losses to commodity producers in the United States -- farmers most of all -- and to commodity producers around the world that have been lulled into using the dollar as their Polaris, their guiding unit of account.

My fundamental disagreement with you, and with all Keynesian and Monetarist demand-siders, is that you devalue the importance of money's function as a unit of account. In classical economics -- which concentrates entirely on production (supply), not consumption (demand) -- transactors in the exchange economy have more concern with money as a constant accounting unit than as a medium of exchange or store of value. In producing and exchanging across time and space, Keynesians and Monetarists automatically downgrade this function of money as they attempt to manipulate the national aggregate economy. The monetarists think they can do this by managing the quantity of money instead of keeping its price constant, using gold as the proxy for all prices. Keynesians cannot break the habit of trying to change the terms of trade with other countries by manipulating the value of the accounting unit. Both theoretical schools teamed up in 1971 to talk President Richard Nixon into breaking the dollar's link to gold. What a mess they created.

Your argument is that technological advance should result in a general price decline. But to a classical economist, that's like saying that as modern golfers hit the ball further and further with better equipment, the yardstick should gradually lengthen. When the dollar is kept constant in terms of gold, technological advances are translated into shorter units of time needed to produce goods and services. If you look at prices over long periods when the dollar (or any other currency) was equated in terms of gold, you will note that prices of primary goods (such as a loaf of bread or suit of clothes or unit of housing) remained constant, but that all workers shared in technological advances by working fewer hours to maintain a fixed standard of living.

To my original point, about deflating down the progressive tax ladder, you no doubt see my point that marginal tax rates that are higher than they need to be to generate revenue in an optimum economy will decline with positive effects. It would be much cleaner to legislate the lower rates, I think you would agree. The mountain should not have to come to Mahomet. The benefits to the world economy are especially relevant when the dollar is not deflating for reasons that are unique to the U.S. economy. In other words, the arguments you make in a closed U.S. economy are not so hot when you take into account our country's global responsibilities. It might work if our government announced a specific plan to deflate by a definite amount, against gold, such as a crawling downward peg. But what's the point?

In your essay, you note that the U.S. economy did very well in the years 1873-1896 even though prices steadily fell throughout. Economists view the period as the first "Great Depression," but you correctly note that other statistics "shows the period to have been one of unprecedented growth and prosperity." You need to do more homework, though, and you will find the period from 1873 to 1879 phased in a return to the gold standard that was suspended during the Civil War. The Congress in 1873 decided to deflate the gold price, which had floated to $40 an ounce, back to its pre-Civil War parity of $20.67, resuming payment of specie on the first business day of 1879. This was one of the worst periods of civil unrest in the nation's peacetime history, as farm prices that had doubled with gold were eventually halved, as were industrial wages. The enormous economic growth you observe in old statistics occurred AFTER resumption in 1879, when the unit of account once again was constant in terms of gold. Prices of a wider basket of goods did fall somewhat, between 1879 to 1896, because there was a lag as workers fought wage cuts. By 1896, the general price level was back to where it had been prior to Greenback era.

In any event, your exercise is useful just to watch the variables at play. It is not useful, I'm afraid, as a policy blueprint. Give it another go.