This is the phase of reflation. The market failure, at this stage, is so pervasive that all the self-balancing and allocation mechanisms are rendered dysfunctional. State intervention is needed in order to restart the economy. An injection of money through a fiscal stimulus, a monetary expansion, a lowering of interest rates, firm support of the financial system, tax and other incentives to consume and to import. Unfortunately, all these goals are best achieved by engaging in warfare. It is often the case: a convenient war reflates the economy, re-ignites the economic engine, generates employment, and increases consumption, innovation and modernization. But with or without war - people sense the demise of an old cycle and the imminent birth of a new one, fraught with uncertainty and ignorance. They rush to buy things. Because the economy is just recovering from deflation - there aren't usually many things to buy. A lot of money chasing few goods - this is a recipe for inflation. Back to phase one. But the various phases of the cycle are not only affected by psychology - they affect it. During periods of inflation people are willing to take on risk. The risk of inflation is clear to them and the only compensation is through higher yields (returns, profits) on financial instruments. Yet, higher returns inevitably and invariably imply higher risks. Thus, people are forced to offset or mitigate one type of risk (inflation) with another (credit or investment risk). Paradoxically, an inflationary period is a period of certainty. Inflation is certain. People tend to develop an ideological type of economics. Based on the underlying and undeniable certainty of ever-worsening conditions, the intellectual elite and decision-makers resort to peremptory, radical, rigid and sometimes coercive solutions backed by an ideology disguised as "scientific knowledge". Communism is a prime example, of course - but so is the "Free Marketry" variant of capitalism, as practised by the IMF and by central bankers. Deflation, on the other hand, is usually a much shorter period. People do not expect it to last. They fully expect it to be followed by inflation - they just do not know when. Thus, its nature is more transitory. Assured of low prices and preoccupied with economic survival - people become strongly risk averse. While in times of inflation people are seeking to protect the value of their money - in times of deflation people are in pursuit of sheer livelihood. A dangerous "stability" sets in. People invest in land, cash and, the more daring, in bonds. Banks do the same. In such times, ideologies are the first victims. They are replaced by philosophies and worldviews. People become much more pragmatic. They look to the possible rather than to the ideal. Communism is replaced by Socialism, Capitalism replaces Free Marketry. Perhaps this is the only good outcome of deflation. (Article published November 9, 1998 in "The New Presence") Return