The price is right: deflation has a bad name. But when productivity is increasing, prices should be allowed to fall

National Review, March 23, 1998 by George Selgin

Most economists now agree that it is a good idea to allow the price level to rise somewhat when productivity suffers a serious setback -- as it did, for example, following the OPEC-sponsored oil shortages of the 1970s. The arguments for letting the price level fall in response to improvements in productivity are less well appreciated, but no less sound.

Everyone accepts the basic principle when it comes to particular firms and industries. Recent reductions in computer prices, for instance, have harmed neither the computer industry nor the U.S. economy as a whole. But the computer industry is only one of many that have witnessed substantial gains in productivity in recent years. Indeed, there is hardly a good or service that isn't being produced more efficiently today than was the case in years past. So what harm could there possibly be in allowing general improvements in productivity to be reflected in general price cuts? The answer is, No obvious harm at all, apart from the psychological anguish felt by certain Fed officials and economic pundits every time the CPI threatens to decline.

In a passage of his speech that seems to have gone unnoticed by most commentators, Mr. Greenspan conceded that deflation is not dangerous so long as it is based on overall gains in productivity. Well, overall annual gains in productivity have been the rule rather than the exception in the U.S. economy; and recent productivity growth has been especially pronounced. Thus, far from being something to fear, steady, mild deflation is something we ought to welcome. Mr. Greenspan, bring on those lower prices. The doomsayers can cry all the way to the supermarket.