The arguments here seem to me to be extremely bad. That is why I am posting them. So we can consider them. I will write some more comments and repost later in the day. Now I need to shower and go to work!!
According to some analysts, deflation is about to devour the world economy unless inflationary policies are implemented urgently. Quite apart from the fact that we are still far from deflation happening (inflation in the UK is 3 per cent and in the eurozone 1.9 per cent), the idea that deflation must inevitably trigger a self-sustaining depression is simply mistaken. There are five ways in which deflation is supposed to plunge the world into a spiral of economic contraction. First, once deflation has started, falling prices will make people put off spending, causing prices to fall further. Second, with prices falling and the value of debt fixed in nominal terms, the real indebtedness of households and firms will grow, acting as a drag on the market, as in Japan since 1990. Third, nominal interest rates cannot fall below zero because companies and households always have the choice of holding cash, which gives a zero return. Banks cannot therefore offer interest rates below zero to depositors so cannot charge negative nominal interest rates on loans. The demand for loans will fall, shrinking the banking sector and the economy with it. Fourth, because nominal interest rates cannot turn negative, central banks will be powerless to offset the effects of deflation. Finally, with prices falling and nominal interest rates stuck at zero, real interest rates will keep increasing, turning the deflationary screw.
In fact, all of these supposed effects either do not matter much, or are the result of inflation being lower than expected, or happen because institutions have not yet adjusted to a potentially deflationary world. They are not the inevitable result of falling prices.
For example, we have experienced falling nominal prices in computers and telecommunications for decades, and although we may think twice before buying that new computer, we buy it in the end. We are not put off those long-distance phone calls at all. That is because it is quite difficult to put off the consumption of many services. And with services accounting for three-quarters of many advanced economies, most activity will be protected from significant delays in purchases.
Real indebtedness rises not only with falling prices, but also as borrowers misjudge future inflation. This is one of the main recessionary forces at a time of falling inflation. Neither is it true that interest rates cannot fall below zero. Companies cannot hold billions of dollars in cash for security reasons. The costs of warehousing cash and making cash payments are likely to be higher than the negative nominal interest rate that banks would want to charge for taking deposits and making bank transfers. In an economy such as America's where cash accounts for less than 2 per cent of gross domestic product, cash warehousing capacity is very low, so that its price could well be sufficient to accommodate negative deposit rates of several per cent a year.
If banks are paid for holding deposits, they will be willing to pay out interest on loans, as long as this interest is lower than the interest they receive on deposits to cover their costs (including credit risk). Bonds and bills can just as easily bear negative interest rates. You simply get less money back at maturity than you paid. Thus, a slide into a mild annual deflation of 1 to 3 per cent need not be much to fear. Indeed, much of the world went through such a period during the last three decades of the 19th century, the golden age of the gold standard. Some economists warn that the US is already in deflation because price indices underestimate quality improvements and therefore overestimate price increases by 1-2 per cent. But they forget that this also implies that output growth is underestimated by 1-2 per cent. Four to five per cent growth with zero to -1 per cent inflation does not sound that bad for the US this year.
After four decades of inflationary bias, some central banks have not adjusted to the threat of deflation. For example, the ban on the European Central Bank financing government deficits would need to be changed, if interest rates could not be driven far enough below zero, to pump cash into the economy. Fortunately, the US Federal Reserve and the Bank of England are not subject to this restriction. Finally, it is possible to impose negative interest rates even on cash. Governments could impose a penalty on cash used for tax payments. Since cash derives its value from government's willingness to accept it at par in settlement of tax obligations, such a penalty would depreciate cash compared with electronic payments.
So, with negative nominal interest rates possible, a deflationary spiral need not happen as prices fall. Of course, deflation is no more desirable than inflation. And a sharp plunge into deflation as in the Great Depression, when prices fell by 10 per cent a year, would be disastrous. But occasional deflation should not be an excuse for abandoning the low inflation we have achieved at such a high cost over the last 20 years. True price stability would change people's attitude towards saving and lay secure foundations for growth. We must not throw this prize away for fear of an imaginary threat.
Source: Financial Times