Read this one. It's an article by a French "journalist, economist, philosopher and author" (according to wikipedia) that celebrates economics' "reach[ing] the threshold of scientific rationality." In the article, the author attempts to distill ten fundamental economic propositions that, in his opinion, would generally be accepted by leading economists. (In the interest of disclosure, Mr. Sorman is a somewhat controversial writer, and the article was published in a magazine called "City Journal," a publication of the Manhattan Institute, which is a conservative/free-market organization based in NYC. If you are prepared to dismiss the article on that basis alone, that's a shame.)

Given the prevalence of economic discussions on this board, from minimum wage to gas prices to free trade and on, I would strongly recommend this as reading for everyone here. I think it does a decent job of summarizing some broad and important economic themes that make their way into PB discourse.

You certainly don't have to agree with the propositions, but if you intend to criticize free-market economics in a relevant way, you certainly should be prepared to refute them.

As a teaser for the complete article, the propositions are the following:

To be sure, these propositions do not reflect the universe of generally accepted economic principles. For example, I would add the following proposition: "#11. Incentives matter." Nevertheless, if you want a good introduction to some broad themes, this is a great place to start.

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"Everything that guy just said is bull$h!t! Thank you."

-- Vincent LaGuardia Gambini

I was going to comment that combine to make a lot of people very angry but he addressed that nicely at the end of his article.

I have a question about #6.
I have read that deflation is worse than inflation, within reason of course, and that the central banks usually aim for slow inflation. Is this an example of erring on the side of caution, or a dispute between academics and the central bankers?

On one hand, deflation is worse than inflation for a psychological reason. Most people get a cost-of-living raise each year which isn't really a raise as it is intended to compensate for inflation. However, most people see it as a raise and thus would see a cost-of-living decrease as a pay cut even if their salary is still nominal. Thus, durind deflation, employers are often forced to layoff workers because they cannot reduce wages.

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City air makes free.

As much as I admire the work of Milton Friedman, I am terrible with monetary policy, so everything I'm about to say might be wrong. With that introduction:

I think what you've written explains part of the problem. Certainly the downside "stickiness" of many prices (especially, as you have noted, labor) can squeeze certain employers, potentially leading to bankruptcies as the price of goods fall, but the cost of labor remains relatively high. Also, there is a risk of a deflationary spiral in which people delay purchases, expecting prices to fall further, which causes a drop-off in demand, with commensurate effects.

The other part relates to the impact of inflation and deflation on interest rates. Nominal interest rates represent the sum of two components: real interest rates and inflation. The real interest rate represents the "cost of money" in the sense of being the amount you have to pay someone, in the absence of inflation, to borrow money. But, because money is, in effect, a commodity, the cost of money is subject to the impact of inflation. Thus, to enable sellers of money (i.e., lenders) to earn a sufficient return both to account for the impact of inflation as well as to earn a profit on the "sale," they need to charge an interest rate equal to the real interest rate plus inflation. (This explains, for example, why long-term mortgage rates have been rising recently; because expectations of higher inflation have increased.)

This system may work when you have inflation, but if the nominal interest rate has been reduced to zero, borrowers are still paying a real interest rate equal to the expected rate of deflation. To steal an example from Ben Bernanke, quoted from a 2002 speech:

Moreover, just as inflation helps borrowers by enabling them to repay fixed debts more cheaply with inflated dollars, deflation crushes borrowers by forcing them to repay fixed debt with deflated dollars.

Turning again to Dr. Bernanke:
Lastly, deflation constrains the most powerful policy tool at the Federal Reserve's disposal -- namely, its ability to set short-term interest rates. Because the Fed can't lower nominal interest rates below zero, once nominal interest rates reach that point, the Fed can't stimulate the economy any further through its interest-rate mechanism. Therefore, if nominal interest rates are at zero, but the economy is still in the dumps, the Fed has been deprived of one of its most powerful tools for economic stimulus. If my recollection is correct, this is the problem that plagued Japan all through the 1990s.

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"Everything that guy just said is bull$h!t! Thank you."

-- Vincent LaGuardia Gambini