Recessions are deflationary by nature?

Posts 352

Points 5,500

Reply

jimmy Posted: Sat, Mar 1 2008 12:20 PM

rated by 0 users

I've often heard that recessions are deflationary by definition, but I'm struggling to understand the mechanics of this. If there is no monetary contraction, why would prices fall? Is the argument basically that velocity is entirely responsible for the fall in prices? If so, what triggers or is the driving force behind this lackluster velocity?

| Post Points: 20

Posts 219

Points 3,910

Reply

Mark B. replied on Sat, Mar 1 2008 12:24 PM

rated by 0 users

They are not deflationary by nature. In fact, you can actually have stagflation, where you have price increases combined with non existant growth.

For a true deflation to take place, the Federal Reserve would have to begin calling in the money supply and that won't happen.

Recession is solely the result of malinvestment and is not tied to deflation

If ye love wealth greater than liberty, the tranquility of servitude greater than the animating contest for freedom, go home and leave us in peace. We seek not your council, nor your arms. Crouch down and lick the hand that feeds you, and may posterity forget that ye were our countrymen.

| Post Points: 20

Posts 352

Points 5,500

Reply

jimmy replied on Sun, Mar 2 2008 12:58 PM

rated by 0 users

Thanks Mark. I finally found some answers on the deflation problem, in the very stats published by the St. Louis Fed:

http://tinyurl.com/2lylec

In short, recessions aren't deflationary at all. None of the last 9 recesssions show any decrease in consumer prices during these recessions. On the contrary, many of them saw sharp increases in consumer prices. One noticable exception in earlier recesssions is the Great Depression, but then this was accompanied by monetary contraction (so we could hardly attribute the deflation in that time period to the recession itself)...

The PPI, on the other hand, saw sharp decreases in the 1987 and 2001 recessions - although certainly not in all recessions (roughly half of them according to my count):

http://tinyurl.com/2uu5zz

This is consistent with the Austrian Theory of Business Cycles which predicts a decrease in demand (and consequently in prices) for what have been (through inflation) largely subsidized sectors of the economy concerning higher order goods, accompanied by shortfalls supply side for those lower order (consumer) goods that were penalized by that same inflation.

However, I imagine the trends in all of the "recessions" as recorded in the statistics above have been skewed by the varying ways in which the Fed reacted to economic data (sometimes being more and sometimes less vigilant about inflation and adapting their monetary policy accordingly). So each of the recesssions would need to be dealt with individually in the context of the exact monetary policy applied at the time in order to better understand the problem.

None the less, at the very least I think I can conclude that all this talk about recessions being deflationary is complete nonsense and no doubt harks back to the most severe recession in living memory which actually was accompanied by deflation, that being the Great Depression... but, as already noted, this was also accompanied by monetary contraction which on it's own might explain the price deflation experienced at that time.

| Post Points: 5

Recessions are deflationary by nature?

rated by 0 users This post has 2 Replies | 2 Followers

rated by 0 users
This post has 2 Replies | 2 Followers