Policymakers at the Federal Reserve Bank are concerned about deflation. The conventional wisdom is to lower interest rates. I'd like to suggest a different approach.
In classical economics, deflation is defined by too few dollars chasing too many goods and services. Deflation can be worse than inflation. The Great Depression in the 1930's is a prime example. The answer is to stimulate consumer demand; John Maynard Keynes, the great British economist, believed that increased government spending could help stop deflation.
The FDR Administration largely followed Keynes' advice with the New Deal. Programs such as the Works Progress Administration, the Tennessee Valley Authority and the Civilian Conservation Corps were passed by Congress.
Japan in the 1990's also suffered from deflation. The solution at that time was to lower interest rates for banks. Rates went all the way to zero. But this did not have any effect. People in Japan continued to increase their savings rates, in the belief that things would get worse. This was a self-fulfilling prophesy.
Now, here in the US, we face the same problem. Interest rates are already at record lows. What to do?
A major source of deflation is stagnant wages. Companies have been very successful in holding down wages, by increasing employee turnover and exporting jobs overseas. The real growth in wages has remained stagnant since the 1980's. This has definitely kept inflation at bay. In order to increase profits, they have resorted to price-gouging and consumer borrowing to increase prices.
But because of the collapse in bank lending, consumer borrowing is not as easy as it once was. The solution is to raise wages across the board. If people have more disposable income, they will buy more. And consumer spending is the main driver of the economy.
Another way to stimulate consumer spending is to increase small business lending. Since small businesses create most of the jobs in this country, this would drive down unemployment and also increase consumer spending.
As we learned from the New Deal, it is not one program, but many programs, that bring about economic revival. Things like Health Care reform and banking reform can help. But we must address the problems of unemployment and stagnant wages to further stimulate the economy.