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Deflation and the Global Economy

February 10, 2014

The Liberty Bullhorn

A while back I warned about the deflation threat to the European economy:

When prices fall over time, tax revenues fall with them. This is especially true in economies with value-added taxes, but the deflation effect on tax revenues spills over on income taxes as well. With deflation fewer workers get raises, meaning that there is much less, if any, growth in the income-tax base. A stagnant or a shrinking tax base is not exactly what the governments of Europe’s welfare states want to have on the horizon.

I also explained that businesses are discouraged from making investments and hiring people. Investment costs are paid upfront, or if financed with loans the costs of principals and interest rate are nominally locked over time. However, deflation reduces per-unit revenue over time, making the investment increasingly unaffordable at constant sales and pushing the break-even point into the territory of growing sales. A…

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