THE THREAT OF DEFLATION 65been happening in Japan for decades. When the debt-to-GDP
ratio gets too high, a sovereign debt crisis and collapse of con-
fidence in the currency can result.
Deflation also destroys government tax collections. If a
worker makes $100,000 per year and gets a $10,000 raise
when prices are constant, that worker has a 10% increase in
her standard of living. The problem is that the government
takes $3,000 of the increase in taxes, so the worker only gets
$7,000 of the raise after taxes.
But if the worker gets no raise, and prices drop ten per-
cent, she still has a ten percent increase in her standard of
living because everything she buys costs less. But now she
keeps the entire gain because the government has no way to
tax the benefits of deflation. In both cases, the worker has a
$10,000 increase in her standard of living, but in inflation the
government takes $3,000, while in deflation the government
gets none of the gain.
For all of these reasons, governments favor inflation. It
can increase consumption, decrease the value of government
debt, and increase tax collections. Governments fear deflation
because it causes people to save, not spend; it increases the
burden of government debt, and in hurts tax collections.
But, what is good for government is often bad for inves-
tors. In deflation, investors can actually benefit from lower
costs, lower taxes and an increase in the real value of savings.
As a rule, inflation is good for government and bad for savers;
while deflation is bad for government and good for savers.
There are many flaws in the way the government and econ-
omists think about inflation and deflation. The idea of MPC
as a guide to economic growth is badly flawed. Even if poor
people have a higher propensity to consume than rich people,
there is more to economic growth than consumption. The real
driver of long-term growth is not consumption, but invest-
ment. While inflation may help drive consumption, it destroys