Deflation is a largely misunderstood bogeyman in economics. Ultimately, central banks are scared of deflation because they lose power over conventional stimulus

Deflation is a largely misunderstood bogeyman in economics. Ultimately, central banks are scared of deflation because they lose power over conventional stimulus tools once the interest rates, and consequently inflation, reach zero, or move into negative territory due to market forces outside of the central bank's control. Why does the Fed see a 2% yearly inflation target as good? The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances. Very vague and hand-wavey, but basically just saying that they like to have a 2% cushion between expected inflation and the traditional 0% floor, beyond which lies the spooooooky land of deflation. This 2% gives them room to raise and lower the federal funds rate (short term interest rate) to their heart's content without setting off any deflationary fire alarms in the economy. If you're really interested, here's a good overview from Bernanke (2003) on how and why the practice got started in the 1970s. [2] Ok, let's see what our favorite Austrian economist, Friedrich von Hayek has to say about inflation targeting: "any form of inflation, even mild inflations, ultimately produce the recurring depressions and unemployment which have been a justified grievance against the free enterprise system and must be prevented if a free society is to survive." [1] He argues that inflation distorts signals such as price and profit. This leads to the misallocation of resources to firms that look good on paper, but that could actually be failing to produce meaningful and sustainable economic returns: The initial general stimulus which an increase of the quantity of money provides is chiefly due to the fact that prices and therefore profits turn out to be higher than expected. Every venture succeeds, including even some which ought to fail. But this can last only so long as the continuous rise of prices is not generally expected. Once people learn to count on it, even a continued rise of prices at the same rate will no longer exert the stimulus that it gave at first. One might argue that we are seeing QE inflation, not in the direct economy, but in the investment market - property, stocks, bonds, anything traded not for short-term consumption, but for capital gains. I don't have the data, so I don't know. Ultimately, it doesn't matter if we have small amounts of inflation or deflation, or if we have no change in the money supply at all. Expectations are what matters - if the markets know that inflation will be 10% next year with 100% certainty, they will plan accordingly and prices/wages will rise accordingly (not perfectly as there will be some friction/lag, but better than if nobody knows what to expect inflation-wise). The problem occurs when nobody knows what the hell is going on in the market, and they keep waiting for the Fed to raise interest rates to get back to 2%, but are losing faith because the Fed has kept rates at 0% for 6 years (!) now. It's all about unexpected shocks and how quickly the economy can adjust to new information. Deflation is not to be feared if it is expected, announced, and executed by a central bank. It is to be feared when the central bank is fighting valiantly to bring about a favorable economic background in which they can raise interest rates without slowing down the recovery/growth of the economy. That's when you know they've lost control, that everything is not ok in the financial markets, and when panic takes over. [1] https://mises.org/library/denationalisation-money-argument-refined https://mises.org/library/denationalisation-money-argument-r... [2] http://www.federalreserve.gov/Boarddocs/speeches/2003/20030325/default.htm http://www.federalreserve.gov/Boarddocs/speeches/2003/200303...