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What happens when the government tries to cause disinflation or deflation?Obviously, just as unexpected inflation benefits debtors, unexpecteddisinflation must benefit creditors. In 1980, a 30-year mortgage at14% didn’t look so bad when inflation was 13% annually, and people expectedtheir incomes to rise by at least that rate. By 1986, however, inflation(and wage increases) had fallen to less than 2%, and creditors werecollecting a 12% annual real return on their 1980 loans. Thus, existingdebtors suffer and existing creditors benefit from disinflation.Other impacts of disinflation depend on whether it is brought about byfiscal or monetary policy. Theoretically inflation can be reduced by decreasingaggregate demand or increasing aggregate supply, but policy usuallyacts on demand. Fiscal policy can decrease aggregate demand onlythrough greater taxation or reduced expenditure, both of which shouldlower the real interest rate, to the benefit of new debtors. Other distributionalimpacts depend on the specific policy used. For example, demandcould be reduced by reducing subsidies for big business or by reducingtransfer payments to the poor.THINK ABOUT IT!Under President Reagan there was a big emphasis on supply-side economics,increasing income by providing incentives for production (i.e.,supply). Policy measures for achieving this include investment subsidies,reduced capital gains taxes, and reduced taxes for the rich. Canyou explain why these policies would theoretically increase supply andreduce inflation?The monetary authority, on the other hand, can act to reduce demandonly by reducing the money supply, which increases real interest rates, tothe detriment of debtors. Interest-sensitive sectors of the economy, suchas farming and construction, also lose out. If losers are forced into liquidationor bankruptcy, they may be forced to sell their assets at bargainprices, and it is the well-to-do who maintain the liquidity necessary topurchase those assets. Thus, recessions may generate corporate mergersand increased concentration of the means of production.The claim made for disinflationary policies is that in the short term theeconomy suffers, but in the long term stable money allows for steadygrowth and higher real wages. The problem is that short-term sufferingcan be severe, especially when monetary policy is used to decrease demand.While the jury is still out on the distributional impacts of moderateinflation, the distributional impacts of unemployment caused bydisinflationary policies, as we will see below, are clear.Chapter 17 The IS-LM Model • 339