A conversation with an AI regarding deflation
andrea.parisi | Published: 23 Apr 2024, 9:51 p.m.
I installed a local version of Llama 3, the latest product from Meta and possibly one of the best AI to date. The reduced version using 8 billion parameters can run on your local computer, and is as powerful as last year AI.
So I asked without any previous warning (and thus no steering) about deflation and why it is fought, the view of the Austrian school, and which approach the AI thought was more sound. Despite some initial concern, the answer overall surprised me. I am reporting here my small conversation made of three questions and answers from the AI.
Q: Why is deflation so hardly fought?
Deflation is often viewed as a less desirable economic phenomenon compared to inflation, and for good reasons. Here are some reasons why central banks and governments might be hesitant to fight deflation:
- Risk of debt crisis Deflation can make it more difficult for governments to pay off their debts, as the value of the debt increases over time. This can lead to a debt crisis, where governments struggle to service their debt.
- Reduced consumer spending Deflation can lead to reduced consumer spending, as people may delay purchases in anticipation of lower prices in the future. This can have a negative impact on economic activity.
- Increased uncertainty Deflation can create uncertainty about the future, making it difficult for businesses to plan and invest.
- Risk of debt trap Deflation can lead to a debt trap, where individuals and businesses are unable to pay off their debts due to the increased value of the debt.
- Limited policy tools Central banks have limited tools to combat deflation, as traditional monetary policy tools, such as lowering interest rates, may not be effective in a deflationary environment.
- Risk of deflationary spiral Deflation can lead to a deflationary spiral, where falling prices lead to reduced economic activity, which in turn leads to further price declines.
- Inequality Deflation can exacerbate income inequality, as those who hold assets (such as savings or property) may benefit from the increased value, while those who rely on debt or fixed incomes may be harmed.
- Limited fiscal policy options Governments may have limited fiscal policy options to combat deflation, as they may not have the fiscal space to implement expansionary policies.
Given these challenges, central banks and governments may be more likely to focus on preventing deflation rather than actively fighting it. Instead, they may aim to maintain a moderate level of inflation, typically around 2% annual inflation rate, to ensure economic stability and growth.
Q: The austrian school views inflation as an additional tax burden (it is called the invisible tax). What does the austrian school say about deflation?
The Austrian School of economics, founded by Carl Menger, Eugen von Böhm-Bawerk, and Ludwig von Mises, has a distinct view on deflation. According to the Austrian School, deflation is not necessarily a bad thing, and in some cases, it can be beneficial. Here are some key points:
- Deflation as a correction The Austrian School views deflation as a natural correction to an earlier period of inflation. Deflation can help to reduce the money supply, which can have been artificially inflated during the inflationary period.
- Increased purchasing power Deflation can increase the purchasing power of individuals, as prices fall. This can be beneficial for consumers, especially those who have saved their money or have fixed incomes.
- Encourages thrift Deflation can encourage people to save and invest, as the value of their savings increases over time.
- Reduces debt burden Deflation can reduce the debt burden of individuals and governments, as the value of the debt increases over time.
- Increases economic efficiency Deflation can lead to increased economic efficiency, as businesses and individuals are forced to adapt to the new economic reality and become more productive.
- No need for government intervention The Austrian School argues that there is no need for government intervention to combat deflation, as the market is capable of correcting itself.
However, the Austrian School also acknowledges that deflation can have negative consequences if it is severe or prolonged. For example:
- Risk of debt crisis Severe deflation can lead to a debt crisis, as the value of debt increases and becomes difficult to service.
- Reduced economic activity Prolonged deflation can lead to reduced economic activity, as people delay purchases and investments in anticipation of lower prices.
In summary, the Austrian School views deflation as a natural correction to an earlier period of inflation, and as a way to increase purchasing power, encourage thrift, and reduce debt burdens. However, they also acknowledge the potential risks of severe or prolonged deflation and argue that government intervention is not necessary to combat it.
Q: If you were to compare the view of the austrian school and the view of modern economic theory regarding deflation, which of the two looks more sound and why?
A great question!
Comparing the views of the Austrian School and modern economic theory regarding deflation, I'd argue that the Austrian School's perspective appears more sound, for several reasons:
- Focus on individual actions The Austrian School emphasizes the importance of individual actions and decisions in shaping the economy. They argue that deflation is a natural consequence of changes in individual behavior, such as changes in consumption and investment patterns. In contrast, modern economic theory often focuses on aggregate variables, such as GDP and inflation rates, which can be misleading.
- Emphasis on monetary policy The Austrian School is skeptical of central banks' ability to control the economy through monetary policy. They argue that central banks' actions can lead to unintended consequences, such as inflation or deflation. Modern economic theory, on the other hand, often relies heavily on central banks' ability to stabilize the economy through monetary policy.
- Recognition of the business cycle The Austrian School acknowledges the importance of the business cycle, which is characterized by periods of expansion and contraction. They argue that deflation can be a natural consequence of a contractionary phase. Modern economic theory often downplays the significance of the business cycle or views it as a random phenomenon.
- Focus on the role of credit The Austrian School emphasizes the importance of credit in the economy and argues that deflation can be caused by a credit contraction. Modern economic theory often neglects the role of credit in the economy or views it as a minor factor.
- Less reliance on aggregate variables The Austrian School is less reliant on aggregate variables, such as GDP and inflation rates, which can be misleading. Instead, they focus on individual actions and decisions, which provide a more nuanced understanding of the economy. In contrast, modern economic theory often relies on aggregate variables and assumes that the economy is a stable, self-correcting system. This can lead to a lack of understanding of the underlying causes of deflation and a reliance on central banks' ability to control the economy.
Of course, this is not to say that modern economic theory is entirely flawed. However, when it comes to understanding deflation, the Austrian School's perspective appears more sound due to its focus on individual actions, emphasis on monetary policy, recognition of the business cycle, focus on the role of credit, and less reliance on aggregate variables.
Thank you!
