"Good versus Bad Deflation: Lessons from the Gold Standard Era" is one of the most famous defenses of beneficial deflation in the last twenty years, and the research therein has major implications for Bitcoin's future.
Introduction
Written by Michael D. Bordo, John Landon-Lane, and Angela Redish in 2010, the paper seeks to dispel the myth that all deflation is harmful by examining historical data on deflationary conditions experienced under the gold standard during the late 1800s. They focus primarily on the US, UK, and Germany. They examine whether the deflation experienced then was beneficial or harmful.
Methodology
The methods in this paper are quite technical, but in in a nutshell, they focused on a few key factors:
- money supply shocks
- money demand shocks
- output supply shocks
- price levels
- GDP and income levels
- effects of innovation
The models sought to determine what impact, if any these factors had on one another.
Conclusions
The analysis determined that deflation during the late 1800s was largely beneficial, and that we can separate deflation into two main categories.
| "Good" Deflation | "Bad" Deflation |
|---|---|
| Prices fall because of increased output | Prices fall because of decreased demand for money |
| Output and real wages rise | Output and real wages fall |
Under "good" deflation, innovation and output made goods naturally cheaper, which made real wages rise while nominal prices fell. They found that the gold standard generally had this type of "good" deflation, although "bad" deflation would sometimes occur as part of the business cycle.
Differences From Today
The researchers do note three key differences between then and today that make "good" deflation less likely in the modern era.
- Countries were linked together by a gold standard they did not manipulate.
- Most deflationary periods occurred because of sudden increases in output.
- Economic growth was very large, which softened the blow of any "bad" deflation periods.
Thus, they caution against using modern central banks to induce "good" deflation.
Lessons For Bitcoin
Things every Bitcoiner should know from this paper:
Predictable Money Supply Prompts "Good" Deflation
Part of what makes Bitcoin attractive is the predictable monetary policy. This feature is essential to making "good" deflation occur. To quote the paper:
It is unexpected deflation that produces negative consequences. However... our work suggests that price level changes were large anticipated [during the period].
Thus, Bitcoin could potentially produce even more "good" deflation than gold, since the supply is far more predictable.
The "Money Illusion" Is Hard To Overcome
Despite real wages rising under "good" deflation from 1880-1890, people didn't feel that way. Experts and the general populace alike seemed to think the deflation was harmful. We may have a considerable mental barrier to overcome when pushing hyperbitcoinization.
Burning Sats Is Not Beneficial
Some Bitcoiners rejoice when sats are burned, and many Ethereum advocates say that if they reduce the supply of ETH overtime, it will expand the Ethereum ecosystem. This paper disproves that notion.
Our results show that the deflation in the late nineteenth century gold standard era in three key countries reflected both positive aggregate supply and negative money supply shocks. Yet the negative money shock had only a minor effect on output. (emphasis added).
The supply of gold shrinking had little to no effect on output. If you want to increase prosperity, build new tech. Don't burn sats like the Ethereum bros do.
Money Neutrality Doesn't Hold (ie, Money Matters)
Throughout the analysis, it was found that output was not completely independent from the monetary environment. Countries did not recover in the long-term after even short-term inflationary shocks, despite contemporary claims to the contrary.
This is another arrow in our quiver to show that Bitcoin isn't just a faster horse. It's stable nature can and will have a long term impact on economic output.
Conclusion
"Good versus Bad Deflation" is a fantastic paper with lessons for all Bitcoiners. Deflation can be either "good" or "bad", depending on whether it is caused by supply or demand side shocks. Modern central banks are ill-suited for inducing "good" deflation, with Bitcoin being a preferable, although not perfect, alternative.