Greenspan and his ilk seem to be fighting yesteryear's war against a
long-slain monster. The obsession with price stability led to policy
excesses and disinflation gave way to deflation - arguably an economic
ill far more pernicious than inflation. Deflation coupled with negative
savings and monstrous debt burdens can lead to prolonged periods of
zero or negative growth. Moreover, in the zealous crusade waged
globally against fiscal and monetary expansion - the merits and
benefits of inflation have often been overlooked.
As economists are wont to point out time and again, inflation is not
the inevitable outcome of growth. It merely reflects the output gap
between actual and potential GDP. As long as the gap is negative -
i.e., whilst the economy is drowning in spare capacity - inflation lies
dormant. The gap widens if growth is anemic and below the economy's
potential. Thus, growth can actually be accompanied by deflation.
Indeed, it is arguable whether inflation was subdued - in America as
elsewhere - by the farsighted policies of central bankers. A better
explanation might be overcapacity - both domestic and global - wrought
by decades of inflation which distorted investment decisions.
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