Deflation bad for government, not so much for you and me.

According to Marketwatch, Federal Reserve Chairman Ben Bernanke warned against deflation:

He also said the risk of deflation, a steady decline in prices and wages, remained a threat.

He stressed to the Senate panel that deflation would increase debt burdens and lower living standards.

If prices and wages declined at the same rate, how would that hurt us? We’d make less, but our expenses would go down. Yes, it would hurt somebody in debt, but it would help the person holding that debt, i.e. savers.

Now, who would get hurt the most? Who owes the most money of anybody? THE UNITED STATES GOVERNMENT.

What the Federal Reserve fears is the real value of the government’s debt increasing, making it harder to pay back. Furthermore, in a deflationary environment, the Fed would lose its ability to keep rates low and inflate the money supply. How so? Currently, if inflation is about zero, the Fed can keep interest rates near zero as well. But if we have deflation of two percent, the Fed can’t really lower rates below zero, so the inflation adjusted interest rates would be two percent. In effect, the government will be paying a two percent interest rate, increasing its deficit and expanding the debt, and the Fed will lose control of interest rate policy.

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