The Theory and Countermeasure of Deflation

The underlying reason for deflation is oversupply and deflation can be divided into anticipatory deflation and innovation-deficient inflation. Anticipatory deflation means there is still demand, but the market is expecting the price to decline, so rational consumers will choose hoarding, thus oversupply exists. It often appears in a market of shortage of economy. Innovation-deficient deflation refers to the lack of consumption hot spots given the current level of income. It tends to occur in an excessive market economy. One of the theories of mainstream economics to deal with deflation is the Keynesian theory. This paper argues that the Keynesian theory system has inherent contradictions: Keynes's theory of productivity is that it changes cyclically, and it is expounded from the perspective of production capacity. If the theory is true, deflation is a regular event that is bound to exist in the market economy and this opposes the Keynesian doctrine of the government's driving the market when the market suffers from demand deficit. Keynes's IS-LM model uses interest rate as the only exogenous variables, with GDP, aggregate supply and aggregate demand as endogenous variables for interest rate. If the model is correct, the government or other external factors can not regulate exogenous interest rate and need not regulate other endogenous macroeconomic variables that have been determined by the model, so the IS-LM model is bound to oppose the government's intervention in the market when there is insufficient effective demand. The "squeeze effect" especially, derived by the model, stating that government investment will inevitably squeeze out the business investment, poses challenge to the effectiveness of the government’s role to stimulate the economy. The real support for the government to stimulate the effective demand for the market is Keynesianism, which is without any theoretical basis. In fact, when there is market downturn, government’s increasing investment or consumption allow the government spend less money from taxpayers and gain more services. This is in line with government rationality; when the price is going down, to increase government investment and consumption are in line with the law of the invisible hand to regulate market demand through price, thus it is an act to support rather than replace the invisible hand. More importantly, when the market is expecting price to be down, government’s investment or consumption can effectively change the market pessimism, boost market confidence, thus is effective measures to respond to the anticipatory deflationary. When there is innovation-deficient deflation, the market can maintain a certain degree of stability if the government stimulates demand, and time and space can be won by market restructuring and innovation. However, the market will grow dependent on the government to stimulate economic growth, thus the problem of innovation-deficient deflation cannot be fundamentally solved. Another theory of mainstream economics to cope with deflation is innovation theory. This paper supports innovation as a powerful measure to cope with innovation-deficient deflation, but does not accept innovation theory from mainstream economics. The common flaw in these innovative theories is that they do not take into account market demand. Just as we oppose the supply economics theory, insisting that supply unaccepted by the market does not generate effective demand, the innovation that is not accepted by the market cannot cope with innovation-deficient deflation. This article systematically criticized the mainstream innovation theory, maintaining that market competition is bound to force the enterprise to innovate, and the exploration of the unknown will inevitably lead to the innovation in basic theory, but by what people or organizations and at what time to carry out influential market innovation, this is a question of uncertainty and probability. There is no definite theoretical model for innovation, and the work that can be done is simply to provide a good policy environment for innovation. The most negative theory to cope with deflation in mainstream economics is the theory of business cycle, which argues that the market economy presents a cyclical fluctuation of expansion, recession, depression, recovery and expansion, and deflation is only a manifestation of cyclical laws. If the theory is true, the market economy with repeating boom-and-bust cycles is inefficient, and we can only wait negatively. In fact, the market price expectation of cheap sale and expensive buy is one of the important reasons leading to fluctuations in the market economy. What else behind the volatility of the market economy is technological innovation? Large scientific and technological innovation will bring a prosperous market, while small one will bring recession to the market prosperity to products or industry. But the lack of it will bring recession to the market. Technology innovation takes time, and we are not sure how long it will be for a major innovation affecting the market economy to come. The market will have bubble, and cannot predict when the bubble will appear either. The so-called laws of business cycle in mainstream economics are merely summaries of the market volatility in a metaphysics way and believe that the law of market fluctuation cycle in the history holds true for the future without reason. The theory of debt-deflation, put forward by Fisher in the 1930s, and raised again in the 1880s, was a theory to deal with deflation. It is one that makes the worst mistake of putting the cart before the horse. In the deflation period, with the decline in prices and the shrinking of the market, companies’ ability to repay debt will inevitably be reduced. With the decline in the market value of the financing collateral, the risk of the lender to exercise his right will inevitably increase, therefore, serious deflation is bound to bring debt risk. In reverse, debtor's debt collection or behavior of additional collateral will increase the deflation. Fisher's debt-deflation theory argues that over-indebtedness of businesses or consumers leads to deflation and hopes to solve the deflation problem by debt re-balancing, which clearly confuses the causal relationship between deflation and over-indebtedness. This paper, with the concept of Keynesian potential output, strictly defines deflation with such two indicators as the potential output and price. We believe that when the actual output is less than the potential output, deflation arises in the market. If the price is still going down, it indicates that the deflation has not yet reached the bottom; if the price began to stabilize, it indicating that deflation has reached the bottom; if the price began to rise, it indicates that the situation of deflation has begun to improve; when the actual production capacity rise to the point of potential output , deflation is over. Grounded on reasons behind deflationary, this paper divides deflation is into Anticipatory Deflationary, when price is expected to be even lowered, and innovation-deficient deflation, when there are no hotspots for consumption due to the lack of innovation. For the two types of deflation, we also put forward our response.