Wednesday, January 22, 2014

WSJ article on great depression

A January 5th article in The Wall Street Journal described the economic situation in Europe by saying "Anxieties are rising in the euro zone that deflation-the phenomenon of persistent falling prices across the economy that blighted the lives of millions in the 1930s-may be starting to take root as it did in Japan in the mid-1990s." Really, blighted the lives of millions? When was the last time you were "blighted" by a store's mark down? If you own a business, are you "blighted" when your suppliers drop their prices?

The Journal is advancing a classic "wet sidewalks cause rain" argument, confusing and inverting cause and effect. It suggests that falling prices caused the Great Depression and in turn the widespread consumer suffering that went along with it. But this puts the cart way in front of the horse.  The Great Depression was triggered by the bursting of a speculative bubble (resulted from too much easy money in the latter half of the 1920s). The resulting economic contraction, prolonged unnecessarily by the anti-market policies of Hoover and Roosevelt, was part of a necessary re-balancing. A bad economy encourages people to reduce current consumption and save for the future. The resulting drop in demand brings down prices.

But lower prices function as a counterweight to a contracting economy by cushioning the blow of the downturn. I would argue that those who lived through the Great Depression were grateful that they were able to buy more with what little money they had.

Imagine how much worse it would have been if they had to contend with rising consumer prices as well. Consumers always want to buy, but sometimes they forego or defer purchases because they can't afford a desired good or service. Higher prices will only compound the problem. It may surprise many Nobel Prize-winning economists, but discounts often motivate consumers to buy - try the experiment yourself the next time you walk past the sale rack.