Sunday, September 2, 2007

Looking beyond the mortgage mess: Should the government fix the mess?

We need to think beyond the mortgage crisis and consider the greater danger of deflation.

Deflation happens when consumer prices decline over time. It's especially hazardous for a society in debt (because your assets are worthless while your debts remain the same) The way it could work now is that as more houses are repossessed & sold at a discount, those houses compete with houses already on the market, pushing prices down. For most of us, our home is our most important financial asset.

We don't have to travel back in time to see the implications: Just look at Japan, where deflation has been a problem since the 1990s.

As we debate public policy, one of the biggest problems with deflation is that governments have few tools to counter its effects. A central bank can only drop interest rates to zero.

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