Most economists agree that deflation is both a disease and a symptom of other economic problems. In Deflation: Good, Bad and Ugly, Don Luskin of Capitalism examines James Paulson’s distinction between “good deflation” and “bad deflation”. Paulson’s definition clearly sees deflation as a sign of other changes in the economy. He describes “good deflation” as deflation that occurs when firms are able to produce goods at ever lower prices because of cost cuts and efficiency gains. This is the second of the four factors contributing to deflation, “the increase in the supply of other commodities”. Paulson calls it “good deflation” because it allows “strong GDP growth, soaring profit growth, falling unemployment and no inflationary consequences”. Paulson simply said, “Serious deflation has occurred, because even if sales price inflation still tends to be lower, companies can no longer keep pace with cost reduction and/or efficiency improvement.” Luskin and I have difficulties with this answer, because it seems to be only half an explanation. According to Luskin, severe deflation is actually caused by “the revaluation of a country’s currency account unit by a country’s central bank”. Essentially, this is the real factor 1 “the decline in money supply” from our list. Therefore, “bad deflation” is caused by the relative decline of money supply, and “good deflation” is caused by the relative increase of commodity supply. These definitions are inherently flawed because deflation is caused by relative changes. If one year’s commodity supply increases by 10% and that year’s money supply increases by 3%, is this “good deflation” or “bad deflation”? We have “good deflation” because of the increase in commodity supply, but since the central bank has not increased the money supply rapidly, we should also have “bad deflation”. Asking whether “goods” or “money” leads to deflation is like asking, “When you applaud, is it the voice of the left hand or the right hand?” Saying “commodity growth is too fast” or “money growth is too slow” is essentially the same thing, because we compare commodities with money, so “good deflation” and “bad deflation” are terms that may be retired. Considering deflation as a disease tends to lead to more consensus among economists. The real problem with deflation, Luskin says, is that it creates problems in business relationships: “If you’re a borrower, you’re contractually committed to repaying the loan, which represents more and more purchasing power, while at the same time, you’re buying assets at the beginning of the loan. Nominal prices are falling. If you are a lender, in this case, your borrower is likely to default on the loan you lent him.