Sunday, October 14, 2012

Keynes on the Nature of Deflation

I have not read Keynes’s A Tract on Monetary Reform (1923) in a while, but I was struck by the following passage on a recent re-reading of the work. This is Keynes arguing against post-war deflation in Europe after the First World War:
“In the first place, Deflation is not desirable, because it effects, what is always harmful, a change in the existing Standard of Value, and redistributes wealth in a manner injurious, at the same time, to business and to social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive.

But whilst the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result, there is another, more violent, disturbance during the period of transition. The policy of gradually raising the value of a country’s money to (say) 100 per cent above its present value in terms of goods … amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands, and to every one who finances his business with borrowed money that he will, sooner or later, lose 100 per cent on his liabilities (since he will have to pay back in terms of commodities twice as much as he has borrowed). Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process. It will be to the interest of everyone in business to go out of business for the time being; and of everyone who is contemplating expenditure to postpone his orders so long as he can. The wise man will be he who turns his assets into cash, withdraws from the risks and the exertions of activity, and awaits in country retirement the steady appreciation promised him in the value of his cash. A probable expectation of Deflation is bad enough; a certain expectation is disastrous. For the mechanism of the modern business world is even less adapted to fluctuations in the value of money upwards than it is to fluctuations downwards.” (Keynes 1923: 143–144).
Keynes, then, was well aware of the debt deflationary effects of price deflation from early in his career, and the way in which price deflation penalises businesses that have borrowed money.

Keynes, John Maynard. 1923. A Tract on Monetary Reform. Macmillan, London.


  1. I pointed out some time ago that the Austrian love of deflation is probably partly influenced by this group's marked tendency toward hoarding. The implications of deflation are worse than Keynes thought: it doesn't reward rentiers so much as it rewards anti-social hoarders. Think Austrian cranks with fallout shelters full of gold whose "investment strategies" are generally made up of removing wealth from circulation.

  2. The Americans who have fallen for the Austrians' gold standard con promoted by the likes of Ron Paul assume that this system would preserve their current living standards. It doesn't occur to them that their living standards would have to collapse, in a Malthusian fashion, so that the survivors could live within the constraints of a finite supply of gold.

  3. Would 19th century productivity and standard of living strides have been even greater if there was steady inflation as opposed to many periods of deflation that occurred?

    1. If deflation caused shocked business expectations that led to a lower level of aggregate investment in this period and longer recessions and poorer business cycle expansions, then, yes, it follows that mild inflation would have overcome that pessimism, and would have led to higher employment and real output growth.