Deflating the Inflation Myth

[Editor’s Note; this interview, with Cobden Centre contributor Jesus Huerta de Soto, was by Malte Fischer of Handelsblatt]

Professor Huerta de Soto, the inflation rate in the euro zone is now only 0.4 percent. Is deflation threatening us, as many experts maintain?

Deflation means that the money supply is shrinking. This is not the case in the euro zone. The M3, the broadly defined supply of money, is growing by about two percent, while the more narrowly defined money supply, M1, by more than six percent. Although the inflation rate in the euro zone is below the European Central Bank’s target of barely two percent, that’s no reason to stir up fears of deflation like some central bankers are doing.

By doing so, they are suggesting that lowering prices is something bad. That is wrong. Price deflation is not a catastrophe, but rather a blessing.

You’ll have to explain that.

Take my homeland, Spain. At the moment, the consumer prices there are decreasing. At the same time, the economy is growing by around two percent on a yearly basis. Some 275,000 new jobs were created in 2013 and unemployment fell from 26 to 23 percent. The facts contradict the horror scenarios of deflation.

Does that mean we should be happy about deflation?

Certainly. It is particularly beneficial when it results from an interplay of a stable money supply and increasing productivity. A fine example is the gold standard in the 19th century. Back then, the money supply only grew by one to two percent per year. At the same time, industrial societies generated the greatest increase in prosperity in history. That is why the ECB should use the gold standard as an example and lower the target for the growth of the M3 money supply from 4.5 to around 2.0 percent.

If the euro economy were to grow by about three percent – which it is capable of doing if it were freed from the shackles of state regulations – prices would decrease by about one percent per annum.

If deflation is so beneficial, why are people afraid of it?

I don’t believe that the average person is frightened by falling prices. It is the representatives of mainstream economics fomenting a deflation phobia. They argue that deflation allows the actual debt burden to increase, and thus strangles the overall economic demand. The deflation alarmists fail to mention that creditors benefit from deflation, which stimulates demand.

Isn’t there a danger consumers will roll back their spending if everything is cheaper tomorrow?

That is an abstruse argument you hear again and again. Look at how fast the latest smartphones sell, although consumers know that the phones will be sold at a lower cost a few months afterwards. America was dominated by deflation for decades after the Civil War. In spite of that, consumption increased. If people were to put off buying because of lower prices, they ultimately would starve to death.

But lowering prices drives down sales figures and lessens the willingness of companies to invest. Do you want to ignore that?

Sales figures are not crucial for companies, but rather their earnings, meaning the difference between revenues and costs. Sinking sales prices increase pressure to reduce costs. The companies, therefore, replace manpower with machines. That means more machines need to be produced, which increases the demand for manpower in the capital goods sector. In this way, workers who lost their jobs in the wake of price deflation find new work in the capital goods sector. The capital stock grows without resulting in mass unemployment.

Aren’t you making that too easy for yourself ? In reality, the gap between the qualifications of the unemployed and the needs of companies is, at times, quite large.

I’m not claiming the market is perfect. That means it’s crucial that the labor market is flexible enough to offer incentives for creative employers to hire new workers.

What role does politics play?

The problem is that politicians have a short time horizon. That is why we need a monetary policy framework that holds both politicians and unions in check. The euro has this job in Europe. The common currency has removed the option of governments to devalue the currency to cover for their misguided economic policies. Economic policy mistakes are seen directly in the affected country’s loss of competitiveness, which forces politicians to make harsh reforms. Two governments in Spain within one and half years have implemented reforms that I hadn’t even dared to dream of. Now, the economic situation is improving and Spain is reaping the harvest of the reforms.

You may be right in the matter of Spain, but there have been no signs of fundamental reforms in Italy and France…

Which is why conditions there will first have to get worse before reforms come. We have learned from experience that the more miserable the economic situation, the stronger the pressure to reform. The reform successes that Spain and other euro countries have achieved increase the pressure on Paris and Rome. High unemployment in Spain had pushed down labor costs. At an average of €20, or $24.90, per hour, they are now half the rate as in France. That is why the French cannot avoid a drastic economic policy cure, even if the people oppose it. Germany should hold to its budgetary consolidation to keep up pressure on France and Italy.

The ECB is coming under increasing pressure to open the monetary floodgates and devalue the euro. The pressure is coming from academics, financial markets and politicians.

The economic mainstream of Keynesianism and monetarism explains the Great Depression of the 1930s with a shortage of money, which allowed an anti-deflation mentality to develop among academics. Politicians use the academic sounding board to pressure the ECB to reinflate the economy. Governments love inflation because it gives them the opportunity to live beyond their means and pile up huge mountains of debt that the central bank devaluates through inflation. It is no wonder it just happens to be the opponents of austerity policies who warn about deflation and demonize the euro’s set of stability policy regulations. They are afraid of presenting the true costs of the welfare state to the electorate.

The head of the ECB, Mario Draghi, succumbed to the pressure with his promise to save the euro if needs be by firing up the money printing presses. A mistake?

Careful. Until now, Mr. Draghi has been mainly making promises, but has barely acted. Although the ECB has initiated generous money lending transactions, and lowered the prime lending rate, the actual yield for 10-year government bonds of ailing euro zone members is above those in America. Measured on the balance sheet totals, the ECB has done less than other Western central banks. As long as the guardians of the euro are only talking but not acting, the pressure will remain on Italy and France to reform. That is why it is crucial the ECB resists the pressure of the governments and the Anglo-Saxon financial world and buys no state bonds.

What role do the Anglo-Saxon financial markets play?

The Anglo-Saxon press and the financial markets are ostentatiously conducting a crusade against the euro and the austerity policy in continental Europe necessitated by it. I am really no believer in conspiracy theories, but the out-and-out attacks against the euro by Washington and London suggest a hidden agenda. The Americans are afraid that the days of the dollar as a global currency are numbered if the euro survives as a hard currency.

Can the euro survive without political union?

A political union will not draw majority support in the population. It also isn’t desirable because it reduces the pressure for fiscal austerity. The best monetary regime for a free society is the gold standard, with all deposits covered by full reserves and without state central banks. As long as we don’t have that, we should defend the euro because it deprives governments of access to the money printing presses and forces them to consolidate their budgets and make reforms. In a certain way, it has the effect of the gold standard.


  • CrisisMaven says:

    (Price) deflation occurs if a product goes out of fashion (= less demand), the supply goes up at current demand or incomes get redistributed to similar goods (substitution = again, less demand). But the reasoning of the “inflationists” goes like this: “if people see prices falling, they won’t spend money and the economy will contract [even more]”. Well, I can see this at my local bakery – starved people, hardly able to stand up due to their emaciation, clutching bank notes and saying “Oh no, I’m going to hold off till tomorrow, rolls might become even cheaper”. Some already have died that way. My neighbor hasn’t gone to work for days, seeing how petrol went down recently. He says “if this continues, I can fill my tank at half the price”. Ok, the employer has fired him meanwhile, but … you DO have to take advantage of TOMORROWS low prices, haven’t you? Mind you, when we had inflation, it was even worse: the guy at the petrol station would not sell petrol. He always kept saying “Tomorrow, folks, tomorrow, when the price is a little higher. Now PLEASE, move along and come back tomorrow, I have to close for today”. Oh, what nonsense – either way! And how gullible people are.

  • John Spiers says:


    Deflation, like inflation, is strictly a monetary event. Prices fall by category given a wide range of circumstances, for example the one you mention. Falling prices are not in all instances deflation.


  • nec stultior quam a libertarian says:

    “A fine example is the gold standard in the 19th century. Back then, the money supply only grew by one to two percent per year. At the same time, industrial societies generated the greatest increase in prosperity in history.”

    The average OECD real per capita GDP growth rate estimates and data for various periods over the past three centuries:

    1700–1820 – 0.2%
    1820–1913 – 1.2%
    1919–1940 – 1.9%
    1950–1973 – 4.9%
    1973–1990 – 2.5%

    Uh oh.

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