Deflation and economic growth

Abstract

Joseph T. Salerno (2003) argues economic growth has occurred in periods of deflation. The Austrian School’s broad understanding of deflation is underscored by the four definitions offered by Salerno (growth deflation, cash-building deflation, bank credit deflation, and confiscatory deflation). Keynesians, by contrast, define the phenomenon more narrowly, equating it with a negative Consumer Price Index (CPI) and economic contraction. The purpose of this note is to argue that economic expansions have occurred in periods of negative CPI, 1 and to challenge Keynesians to improve upon their narrow definition of deflation. Samuelson (1998), Krugman (1998), and DeLong (1999) are examples of economists working in the Keynesian tradition who equate periods of deflation with economic contraction. Samuelson (1998, p. 337) writes, “A deflation occurs when prices decline (which means that the rate of inflation is negative). ” He writes (pp. 406–07), The opposite of inflation is deflation, which occurs when the general level of prices is falling. Deflations have been rare in the late twentieth century. In the United States, the last time consumer prices actually fell from one year to the next was 1955. Sustained deflation, in which prices fall steadily over a period of several years, are associated with depressions, such as occurred in the 1930s or the 1890s. The classic explanation of a liquidity trap is by Keynes (1936), cited by Krugman (1998). Krugman (p. 141) defines a “liquidity trap ” as “a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the GREG KAZA is executive director of the Arkansas Policy Foundation. He was adjunct professor of finance (1998–2000) at Walsh College. The author wishes to thank Walsh

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