The conventional wisdom, embraced by the Fed and by most economic commentators, is that deflation is bad. And the 20-year economic malaise of Japan proves it. When prices are declining, consumers have no incentive to spend, since whatever they contemplate buying will be cheaper tomorrow. And investors have no incentive to move out of cash, since this riskless asset buys more and more as time passes. Businesses and households want to repair their balance sheets. They are reluctant to assume debt that will represent a bigger and bigger claim on their real wealth and income just with the passage of time and regardless of the rate of interest. As a result, easy money doesn't generate increased bank lending or increased economic activity.
But is there an exception when "deflation" is triggered by a dramatic decline in the price of oil? Certainly, declining oil prices have some painful consequences. They trigger large cutbacks in capital spending for oil drilling and exploration. This reduces demand for oil field labor, for drilling pipes and supplies, for oil field services, and for the inputs those companies use. And it ripples through the economy, lowering the prices of goods where energy is an important input in their manufacturing process. Some energy companies will go bankrupt, putting pressure on the banks that loaned them money.
But that is far from the whole story. Declining oil prices are, for the average family, the economic equivalent of a large tax cut -- around $750 in savings at the gas pump, and an additional $750 for those who use heating oil. This "tax cut" disproportionately helps lower-income groups, just those households with the highest inclination to spend the money they have. All kinds of retail and consumer discretionary goods will be in greater demand. Cheaper gas means more flying, more driving, more hotel occupancy, more use of restaurants and leisure facilities. Some prices will be falling, but the prices of services and of many other products will be drifting upward. And investors, especially those in the "1 percent," won't see declines in the prices they pay for art, prime real estate, tuition at elite schools, meals at fine restaurants, and other luxury goods. Unlike in Japan, cash will not be king. Neither investors nor consumers can prudently assume that it will be cheaper to buy tomorrow, or that cash will provide an adequate return on savings in the longer run.
Cheaper oil also heralds a geopolitical shift, one very favorable for democracies around the world. It's good for America and Europe, Japan and India -- oil importers all. And it's bad for Russia and Iran, for Iraq and Venezuela -- who depend on oil revenues to keep their restive populations at bay or to project power beyond their borders. It's a major wealth transfer from countries that wish us ill to those that wish us well. In short, "deflation," driven by the rapid decline in oil prices, is good news for America, and especially for lower-income groups who have not had much good news since the Great Recession.
This is one "gift horse" we shouldn't be looking in the mouth.
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