The stock market has stumbled for the past few sessions, but the eight-week rally preceding it certainly quelled investor concerns about deflation. Some improving economic data also have eased concerns about deflation, loosely defined as a severe economic contraction accompanied by declining prices, wages and credit. Still, the specter of deflation continues to hover above Wall Street, although a growing number of observers believe such fears are unfounded.
Voice of Authority
"Deflation is a consequence of bad policy, not a cause of bad results," Nobel Laureate Milton Friedman, now a senior research fellow at the Hoover Institution, said in a recent interview. "Declining prices in the 1930s weren't the immediate cause of trouble. It was the declining quantity of money that produced a declining level of spending that produced a declining quantity of prices." Friedman is perhaps the best-known monetarist, economists who believe money supply growth holds the key to the economy's path, as well as trends in inflation/deflation. He's also a controversial figure, as many blame his policy recommendations during his tenure on President Reagan's economic advisory board for the record budget deficits of the 1980s. Still, he's won at least one more Nobel Prize for economics than I have, so I figure his point of view is worth noting, at least. From Friedman's point of view, the Federal Reserve has learned from the experience of the 1930s and Japan in the 1990s and is "not going to allow the quantity of money to decline more rapidly than economic output," which he believes is necessary for deflation to emerge. Indeed, Fed officials have in recent weeks strained to show they understand the threat of deflation and that they will take whatever steps necessary to combat its onset. Most recently, Fed Governor Ben Bernanke said: "The U.S. government has a technology, called a printing press -- or, today, its electronic equivalent -- that allows it to produce as many U.S. dollars as it wishes at essentially no cost." Fed Chairman Greenspan has made similar comments about the central bank's ability to inject liquidity into the economy by means beyond the fed funds rate, which is at its lowest level since 1958.