Such a hard thing to reason out in my non-economist brain. The idea that people won't spend money today because something may be cheaper in the future is bad? That sounds really close to saving money instead of spending it. Many of us are in debt up to our ears from spending past our income, on school or worthless things. We don't buy a car today because we're afraid the car will cost more next year, the car costs are largely stagnate. We don't buy a house today because we're afraid it will cost more next year, we buy a house because a family is growing, we need a place to live, or it will leave the market and we'll miss it. A top of the line iPhone last year was the same price as a new one this year, if we wait its for the last years model. We don't wait to buy food until tomorrow because it might be cheaper. We don't wait to fill our gas tank until tomorrow, we have to get to work today. We don't wait until tomorrow to fill our prescriptions, we need them today. I don't wait to pay my electric or cable bills, I need them today.
Where is it, who, exactly, does this hurt. Who will be sitting on their money, waiting to buy things they need until tomorrow. Only people who already have everything they need, and even then they will continue to buy the basics. Who does this hurt. The roads will continue to be paved, the cities will continue to function. How does this all break down when a dollar today is worth a dollar and a fraction of a cent tomorrow.
We weren't all dying when gas was $1 a gallon were we?
> It hurts everyone as the economy shrinks and there's less cash to go around.
Only until prices fall enough that people start spending again and hiring picks up again.
The idea of an evenly rotating economy where everything is great all the time has been thoroughly disproven over 100 years ago. To try and manage the economy to be so is a fool's errand.
Debt has grown ever-so-slightly faster than income for the last 40-50 years and that means future purchases have been pulled to the present for the last 40-50 years. If history is a guide (and I believe that it is) one of two things will happen:
1. People will start to pay down their debt and this will unfortunately result in hardship as debt-fueled growth stops
2. The banks will print more money and the party never stops until the party blows up in an enormous currency crisis
I can't tell you which will happen, but every time we print more money we grow the systemic risk of total blowup. People who argue that we should be doing more to prevent climate change while simultaneously cheering money-printing need to take a good look at their belief systems.
Deflation is only a scary thing because people have adapted to inflation, and that has shaped the last 100 years or so of financial history in this country.
It used to be that prices went up, then down, then back up again, then back down again, etc on a time-scale of a couple of years. Maybe spanning a range of 4x or so. Because everyone knew that's how things went, they arranged their affairs to cope and things weren't amazing, but a year or two of deflation didn't destroy the world.
What we have now are huge asset bubbles that are popping and people at the Fed are trying to reflate and/or at least slow the collapse down. The problem isn't that deflation might happen; it's that there were years and years of asset prices going to more and more unreasonable levels that no sane person would pay.
How do you clean the slate and get asset prices back to levels that might make sense from a fundamentals perspective instead of a risk-on, risk-off perspective? The only thing I can think of is to let them fall to levels where people would be willing to buy them again. It's either that or a 20 year inflationary slog to slowly reprice them in real terms.
In other words, at 4% inflation over 20 years if a price doesn't change in nominal terms it'll lose 55% of its value in real terms. That roughly approximates it dropping in value 50% in say 6 months nominally, because in 6 months nominal terms are unlikely to diverge from real terms by more than a few percent.
Which would you rather have? 20 year of Japan or the Great Depression, or a fairly swift realignment of the economy to the new realities? Either way the assets have to get repriced once everyone realized that they were priced horribly, horribly incorrectly.
The amount of wealth is constant. Just because there is more cash in the economy, doesn't mean anything if it's worth less. You might see some benefit in the short term but only at the expense of the long term. People, and the economy as a whole, should save/invest for the future as much as possible, rather than only caring about the short term.
Deflation means you can buy the same amount of goods (sustaining the same sized economy) with less money.
That less money means you have more surplus money to spend on luxuries. More people will have more disposable income, which likely would mean they buy more goods, and could sustain a larger economy... leading to economic growth.
Plus-- the goods you're buying are made by companies who are buying materials at a lower cost, and thus if they lower prices slower than the materials prices are going down due to inflation they have more margin.
Businesses as well will have more flexibility, the ones that are borderline now will last longer, might turn things around, etc.
Meanwhile my savings are slowly growing in economic power, even though all I've done is stuff them in an old mattress.
New entrants to the labour market can never aspire to have the kind of cash their older peers have put away because work yesterday is valued more than work today.
If you stop the excessive spending, you may actually pay off your debts prematurely. Guess who it'll hurt? The sponsors of the Economist, the banks and wealthy investors who want at least 2-3% interest for nothing (for lending out money they've accumulated in the past, or money they've generated out of thin air in case of banks).
It'll likely also hurt some countries that have accumulated far more debt than they could ever reasonably hope to pay back. Debt also motivated by the same entities hoping to make a buck from nothing.
I'm not at all afraid. I have no debt and I invest in things that have actual value when used, like real estate. I don't care if prices drop, because it'll still be real estate with practical value.
I think what's really interesting is exploring the dynamics around lowering or raising the interest rate. Lowering it will tend to pull purchases from the future to the present, everything else equal. But -- at least with housing -- all other things aren't equal; lowering the interest rate also drives up property prices.
Once something is expensive enough that say, 95% of the population has to finance it, the purchase price is no longer really a consideration. Sure you might sign on a mortgage that ostensibly says you start out owing $300k or whatever, but in reality what you're signing on is an obligation to pay $2k/month for the next 30 years, or until you sell it, go broke and move out, etc.
At 10% interest the $2k/mo doesn't have all that large of a price-artifact; it's about $200k. At 4% interest, the $2k/mo price-artifact is $375k. This is interesting and serves to illustrate that lowering the interest rate doesn't really "help" real-estate except to ensure that people aren't underwater in houses they paid too much for.
In the non-financing world, a high interest rate means that you get a future-discount by saving your money and buying it later. And a low interest rate means that you get less of a future-discount by waiting to buy. When I say "a high interest rate" I'm talking about the real interest rate, interest minus inflation. The nominal interest rate doesn't matter save for some psychological effects. You can get that by having 10% interest and 4% inflation or 2% interest and 4% deflation, either way the real interest rate is 6%. But when the interest rate is 1% and inflation is 3% then the real interest rate is negative, -2% and you're a fool to save any money at all; everything else equal. This is how lowering the interest rate pulls future purchases into the present.
Here's the kicker though: eventually there's less and less future purchases to pull from, and as a result the inflation has to get ever-more severe. As you start to approach spending all your money on debt service, you have less and less ability to take on new debt. And that means that the terms have to get substantially more favorable, and seemingly the only way to do that is to inflate enough to make the old debt less burdensome. Is that an underhanded form of theft? Probably, but it's the legal kind.
The "hoarding" argument tends to fall apart if you consider all the things which a person HAS to buy; food, water, clothing, shelter, energy, transportation, etc. It's not as though you can not eat your vegetables because they're expensive for 20 years and then make up for that all at once. Can people make do with less? Sure.
One person's "hoarding" is another person's ability to finance a house because the bank has enough savings to make the loan.
I think I follow, but if my $1 today is worth $1.10 in a year, deflation, at 0% interest, that is still 10% more value year to year for the bank making the loan. So $360 of money at the end of a 30 year loan, $1 per month, is worth $2,171.32 dollars in the end. That last $1 payment would be worth $209.39 dollars from the starting point. Isn't the loan still worth giving?
My math is no doubt horribly off, but if each $1 is worth more that the end of the loan, deflation, or if I'm instead paying out more than $1 per month at the end of the loan, inflation, why is the deflated $1 worth less in a relative world view.
Is the interest lost from inflation equal the value gained from deflation?
Yeah it's a totally crazy concept. What you have to do is stop thinking about how many dollars a dollar will be worth, but think about the idea of purchasing power.
So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff.
If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc).
That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not.
The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly.
I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.
Consider what happens with significant deflation going on, say 3%. t is then impossible for real interest rates to be less than 3%. Then purchases get pushed into the future, and the economy grinds to a lower equilibrium, with lots of unemployment. Sound familiar?
> The idea that people won't spend money today because something may be cheaper in the future is bad?
No. Think about what happens to any large organization during deflation.
The counterintuitive part here is that every large organisation, including the government, is worth exactly nothing. Now you might think "But Obama sure has a nice little white house, lots of employees, ... that's gotta be worth something". That's true. Those are the assets. Then you have the liabilities. This includes loans that need to be repaid (plus interest), and any remaining capital is effectively loaned to the shareholders (though in practice this will, nearly always, be zero. The exceptions are Apple, Google and Facebook, but there's other major caveats there).
Now what happens when you have 11% deflation (making an extreme example, nobody's expecting more than 1.1% at the moment).
Before:
* Assets(t-1) = What was produced (sold) - what was consumed (yes, even for the government)
* Liabilities(t-1) = What was loaned
* Worth(t-1) = Assets(t-1) + Liabilities(t-1) = 0
After 11% inflation:
* Assets(t) = 0.9 * What was produced (sold) - 0.9 * what was consumed
* <> Assets(t) = 0.9 * Assets(t-1)
* Liabilities(t) = What was loaned ~= Liabilities(t-1)
(Liabilities, especially loans, but many other instruments as well, are not affected by inflation)
So there you have it : the organisation (say, the US government), effectively has to pay 10% of it's liabilities without getting anything in return for that. Zero liabilities disappear, nothing gets produced, it's literally money down a black hole. So there you have (way, way oversimplified) the problem. When you have deflation, every organisation that is balanced (assets + liabilities = zero), including the government, every large organisation, ... all their loans effectively increase by the deflation amount.
So what would the effect be of 1% deflation :
The US government loaned $17 trillion, so every 1% of deflation means raising tax income by 170 billion (or loaning it, worsening the problem quickly) without getting anything in return at all.
Note that this is just the primary effect. The fact that every loan suddenly becomes more expensive to repay will have all sorts of indirect effects, like say a housing price crash (because banks can be pretty sure nobody will be able to repay even small loans with low interest rates).
Deflation, effectively, is a tax on loans. It will very quickly destroy anyone and anything holding loans, which is to say everyone. Incidentally, fractional reserve banks have a capital buffer of 2%, which means they loan out 50 times more money than they have in capital, all of which will suddenly and simultaneously have problems getting repaid. What do you think will happen to your savings ?
Cynics would say, because the effect this will have on governments, they will go to war. Especially the ones that don't control their own currencies.
(in other words, a piece of advice : if inflation gets to 0%, you won't get interest on the bank anyway. Get your money and hide it under your mattress before everyone else does)
I understand the position I think, we're balancing the Empire State building on the tip. You'll get plenty of folks suggesting that is why gold backed money was better. Heck, that is why we are FDIC insured up to $250k, that covers 99% of Americans right? Doesn't sound bad on the surface, but I've not been alive long enough to witness true chaos.
The way I look at it, high rates of inflation incentivize debt. If I can borrow at %4 a year (much more than the federal reserve charges, for instance) and then deploy that money productively, I can use the proceeds to pay down the debt with much cheaper money.
So, if I thought the rate of return made sense, I could borrow dollars on my credit card, buy Apple, Google or Facebook stock, and then pay back the loan on the dividends or returns from the stocks appreciation. This isn't even necessarily irresponsible if, say, you bought Berkshire Hathaway, which has historically returned >%20. If it continues to do so, even a credit card rate of %13 will give you a %7 spread.
This is a simple example of leverage and is effectively the same as trading stock on margin.
But, I'm sure everyone reading this realizes the danger- Buffet may die, BRK might flatten, any of those tech companies might not return what I expect.
That's the risk of leverage.
So, in short, inflation incentivizes the risk of leverage.
And that's exactly what we saw in the housing bubble where people with $60k in income were buying 4-5 $120k condos hoping to flip them in a few years.
Yeah, leverage is probably one of the best/worst concepts to ever happen. It's why an airline goes bankrupt every few years, and the primary reason why banking crises happen.
But leverage is also the thing that allows me to buy a house or a car on credit rather than outright with cash.
Leverage is kind-of like guns. I want me to have it because I'm responsible and can handle it appropriately. But I'm not sure that anyone else should be allowed to have it.
(I'm personally for arming people more rather than less, but it seems like it'll hit home for a lot of folks)
I don't know why people are talking as if deflation is a real thing when there's a worldwide property bubble going on and property price is a a very real aspect of the cost of day-to-day living. One must question the CPI metrics used.
It's a fraudulent concern meant to enable more printing.
One of the many psychological toys the Fed & Co. use, just like they regularly threaten to raise interest rates (for years at this point) to buy more time on holding down the bubbles they've created without having to actually do anything.
The reason so many people are afraid of deflation, is they're from the Keynesian school of economics. They've been brainwashed for two generations to think inflation is how you grow an economy. No coincidence, the Keynesian experiment has been a global disaster of epic proportions, leading to the greatest accumulation of debt in world history; and locally, a 40 year stagnation in the American standard of living, perpetually high real unemployment, increased poverty, and increased inequality (because the rich can shield themselves from inflation, the poor cannot).
Every country in history that has ever attempted to implement a Keynesian inflation based economy, has failed, with the result being a disaster. Such examples include the US, Japan, much of Europe and lately China has signed on to the debt / stimulus / inflation party. Japan is a famous, fake deflation example. They haven't suffered a penny of deflation in 30 years (an inflation based asset bubble imploding, is not deflation); if Japan had suffered decades of deflation, their wages and prices wouldn't be among the highest in the world.
Yup. Total disasters. Higher standard of living than any humans in history, but Japan, Europe and the USA are somehow failed economies and total disaster zones.
I think the poster above is talking about the trends, not the absolute level of wealth.
The standard of living in the US has been stagnant (even declining, for the lower-middle class) since 2000. Japan has been stagnant since the real-estate bubble burst in the 80s.
Oh goodness no, not lower consumption! In 2014 of course we should all be working full time just to have roofs over our heads, assuaging our stress by buying toys that we can't even appreciate before they're obsolete or broken.
The myth that inflation is good is one of the greatest lies used to pervert a seemingly free society into yet another treadmill of sustenance-based slavery.
In a functioning free market economy, most prices should be always decreasing - that is precisely what competition is based on!
But when we fix the CPI, what we get instead is basic necessities still being optimized ever-lower, while the currency is inflated to make energy costs (the only true monetary measure) rise to compensate. Collateralizable assets shoot through the roof as they're used to facilitate the monetary inflation (those who control access to the proverbial printing press taking a hearty cut), and we get to our current point where things that used to be owned are now just rented from banks.
Ask yourself how many people have avoided owning a computer, knowing that prices are always dropping? How many people have gone hungry, figuring that food will be cheaper next week?
I think the theory is not so much that people go hungry because food will be cheaper tomorrow, but that there is a perverse incentive to spend a little less because you'll be able to get a little more with it later. I'm not sure I buy this theory but I think it's more about the macro effects of a small tweak in incentives.
> incentive to spend a little less because you'll be able to get a little more with it later
Yes, I completely agree with this. I just don't think that it's bad. At a certain point, the utility of having the good today surpasses any additional utility that could be achieved by delaying the purchase.
The balance shifts back towards consumption as people build wealth, since the utility of saving decreases. Rather than being encouraged to quickly spend income on goods, saving wealth to spend at any time allows one to plan their purchases and better negotiate for the value of their time.
If you wait a little longer, you can buy a better tablet, a better computer, a better phone, a better TV with the same amount of money (inflation-corrected or not). That doesn't stop people from buying all kinds of electronic devices, even though they get obsolete much faster than their money.
The point is not that it stops people from buying things, but that on a macro scale it will cause people to delay or dampen their consumption. Sites like http://buyersguide.macrumors.com/ show this phenomenon exists, the question is how much of an effect it has when it's a few % yearly discount spread out over every good and service.
I think the question hinges on whether that incentive is "perverse" or not. (Not criticizing your use of the word, it is the perfect word for this point.)
I believe it is not perverse because saving allows for investing, and is the basis of capitalism- the accumulation of capital that can be deployed productively.
Even if you're just saving on the downpayment of a house- putting %20 vs %10 can save a whole lot of money on a 30 year mortgage, leaving you better off in retirement, etc.
Might be useful to differentiate asset deflation from other forms. Asset deflation is neccessary to spread wealth more evenly around the world. Such a policy is he most "progressive" policy given the current skew of asset distributions. Its possible to de-link asset vol from job creattion. Look no further than the recent inflation of asset values and the lack of net-job adds. So, as it is on the way up...so it is on the way down. The beauty of variance and volatility is that they are naturally "neutral" terms.
The argument that there needs to be inflationary bias to create jobs is weak on many levels. This is just one.
The reason that political establishments have always been biased against monetary deflation can be found in the manner in which wealth transfer occurs under inflationary and deflationary environments.
During an inflationary credit expansion, wealth is transferred from the public in general to the earliest recipients of the newly created credit money. In practice, the earliest recipients are interest groups with the strongest political connections to the state and, in particular, the state institutions that control monetary policy (i.e., the Federal Reserve in the United States). Importantly, the wealth transfer that takes place during an inflation is hidden and largely unrecognized by the majority of the population. The population is unaware that the supply of money is increasing and the attendant rise in prices, ostensibly beneficial to business, initially
"produces [a] general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply — all is saleable and everybody can continue what he had been doing."
In an inflationary environment, wealth transfer proceeds insidiously and is masked by a perceived prosperity. The unmasking finally occurs at the end of the credit boom when the market's tendency to clear prior losses takes hold. Failed businesses are liquidated and their capital is transferred, usually through bankruptcy, to creditors who must acknowledge losses on these misguided investments. Unemployment soars and social unrest replaces the former sense of euphoria attending the credit boom. Professor Hülsmann summarizes the differences between the transfers of wealth occurring under inflation and deflation as such:
"In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. It entails visible misery for many people, to the benefit of equally visible winners. This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers. …
[Inflation] is a secret rip-off and thus the perfect vehicle for the exploitation of a population through its (false) elites, whereas deflation means open redistribution through bankruptcy according to the law."
And here lies the answer to why the state prefers a policy of controlled inflation. Only in an inflationary environment can state largesse be conferred to the politically well-connected without raising public ire. The widespread and visible transfers of property through bankruptcy that must take place during a deflation are often politically destabilizing and thus highly unappealing to any regime. A sense of injustice grows within the population as banks are saved from the folly of their misguided investments with taxpayer-funded bailouts, while debtors with no political clout have property seized in bankruptcy.
Or put another way, with inflation government can promise and raise funds for political programs that help win elections, that they would not be able to pass if they had to raise taxes (or cut other programs) to pay for.
True, but that's not necessarily a zero-sum decision. Use that money for subsidies or handouts, it's certainly wasted and hihgly inflationary. Use it to build a port or some similar infrastructure, and it generates significant real (rather than just nominal) economic activity.
For those that do not understand why deflation is considered dangerous, let me describe it this way:
It is effectively like cash earning tax-free interest. And since it is cash, that "investment" is virtually risk-free because you'll always have the cash.
As a consequence, simply holding cash starts competing with the expected return of investing the cash in other ways, like real estate, government bonds, the stock market, or a startup. Relative to some traditional investments, you might maximize your effective risk-adjusted returns by doing nothing at all!
This sounds great (at least for people with cash) until you realize that this "investment" is one of the least productive investments possible. No infrastructure is built, no technologies invented, no products are created for customers. While people with cash might be nominally wealthier, there is greatly reduced investment of cash in things that improve the productivity and wealth of the entire economy.
Furthermore, real investment is how many jobs are created. Several million jobs in the United States are paid for with funds from speculative investments. If it no longer pays to make speculative investments on new technologies, new startups, or otherwise changing the world, what do you think happens to those jobs that are tacitly funded by that investment?
Mild inflation, for better or worse, incentivizes anyone with a bit of money to use that money to fund companies, infrastructure, technology, and jobs that may ultimately return higher value than the loss to inflation. Yes, if you sit on your cash in an inflationary economy, you slowly lose wealth. It incentivizes people to attempt to apply their assets toward productive ends.
Lastly, there is the question of what about people with little or no cash in an inflationary environment? On the surface, it looks like they get screwed. In practice, the productivity and technology advances created by the investment by people with money are often effectively neutral or deflationary. Not only are they more productive at their jobs, assuming they have one, but the costs of many goods decline thanks to the investment. This doesn't apply to all goods but it applies to many that almost everyone consumes. That said, if an economy inflates too fast it can quickly outstrip the earning potential of the people that operate in it. The flow of money through an economy has a significant viscosity and in extreme cases that causes much suffering.
In summary, the reason mildly inflationary economies are commonly preferred by most governments is that, on the balance, it optimizes incentives to maximize real investment which not only grows the economy in real terms but has quasi-deflationary effects for consumers as well. There are always tradeoffs but this is widely believed to have the "least bad" set of tradeoffs for a currency inflation/deflation policy.
Your argument may have merit, but it oversimplifies an important point (in my opinion)
If money is "hidden under blankets" it is taken out of circulation. The value per unit currency still in circulation increases (due to lack of supply) and this will boost the purchasing power of the money remaining in circulation. For this reason the idea that "deflation causes a liquidity crisis" is a bit misleading- It causes a liquidity crises measured in "face value" but not in "purchasing power" of the currency. (Though some of your prognoses are probably still true but occur because of other, somewhat different mechanisms)
> Mild inflation, for better or worse, incentivizes anyone with a bit of money to use that money to fund companies, infrastructure, technology, and jobs that may ultimately return higher value than the loss to inflation. Yes, if you sit on your cash in an inflationary economy, you slowly lose wealth. It incentivizes people to attempt to apply their assets toward productive ends.
One other point: inflation is actually beneficial to people who are in debt[0], as it reduces the real value of their debt. (In other words, the dollar that they use to pay off the debt a year from now is worth less than the dollar today, so inflation literally allows them to use less money[1] to pay off their debt).
Conversely, deflation is terrible for people who are in debt, as it effectively increases the amount of money they have to spend to pay off the debt (this is on top of the compounding interest; it is looking at the real value of the same nominal dollar amount).
So, one of the biggest dangers of deflation is that it harms people with negative net worth (people deeply in debt)[2].
[0] Assuming fixed interest rates
[1] In real terms, not nominal terms
[2] The people who 'win' in this particular context are the people who own that debt (ie, the bankers). But as jandrewrodgers pointed out, there are a number of other ways that deflation harms them as well, so deflation is really a lose-lose situation.
This, aside from the wage concerns mentioned elsewhere in the comments, is the huge problem with deflation. Anyone with debt (got a mortgage or student loans? This is you we're talking about then) gets a huge kick in the balls, which is compounded by wage cuts or, at best, stagnant wages.
Unexpected inflation is good for people in debt, and unexpected deflation is bad.
If the inflation is expected, interest rates adjust accordingly. India has roughly a 10% inflation rate and interest rates on mortgages tend to be 11-12%. The US has inflation rates of about 1-2% and mortgage rates of 3-4%.
tl;dr; If inflation is I, you'll be paying interest rates of I+R where R is dependent on availability of capital, your risk factors, etc.
This is based on feelings and not fact, just the response to what I've read in this post, and these comments.
Your insights make me feel that a deflationary economy might be better, we're always running, rushing, we can't stop, we have to work harder all the time. To not move forward is to make less money, to be able to not afford this year what you could last year because the peg is always moving. A deflationary environment still rewards workers, because the dollars are worth more, but doesn't punish you for not constantly struggling. If you've gotten a house and you're happy where you are you won't have to worry about not being able to afford it in the future. Without being able to get into debt we would be forced to learn good saving habits.
In this inflationary environment, with a limited savings and limited ability to invest my value is constantly going down no matter how hard I work or how much I learn I am worth less every day than I was the day before. My minutes are worth less, my hours, my free time is worthless now. If you don't job hop, stay in one spot, if you made $100k as a software dev in the 90s, which wasn't out of the question, and you still make $100k now, you're making a whole lot less money.
"A deflationary environment still rewards workers, because the dollars are worth more, but doesn't punish you for not constantly struggling."
It's true you get a small raise each year. But from the business owner's perspective, their costs go up each year. The salary stays the same number but you're paying them more. As you can charge less for your products (deflation means prices fall), you get less money to pay your employee with. So how do you stay in business?
And your employees find it hard to leave because other companies can't match their salary. So it hurts the flexibility of labor to move to more suitable jobs. The result is a stifling and suffocating business environment. Many companies go out of business during deflation.
Exactly. Unfortunately for those employees, their mortgages, student loans, and credit cards are all based on nominal amounts so suddenly they're earning less to service the same amount of debt.
So let's say you are an entrepreneur and you want to open a small business. You need a small loan to cover your startup costs which you can repay with your proceeds.
And flip the coin, you are a bank with cash in your vault which is basically the depositors money.
Now as the bank your deposits become more valuable by doing nothing, than they do by lending them out to the entrepreneur to start his business. So you go with the 'safe' choice, you sit on the money.
The Entrepreneur either can't get a loan, or has to pay an extortionate interest rate because the bank doesn't care, if they don't lend they win.
People stop buying large purchases like dryers or refrigerators because if they just wait long enough the price will come down and they can get a much better refrigerator for their money. So large appliances and other large investments (cars for example) sit unsold, that idles factory workers since there is plenty of stock in the market place. So they get laid off.
Deflation has the effect of contracting the economy, modest inflation tends to expand it.
I guess this would become circular because I'm not well enough informed. Because if the dollar value goes up, the startup costs are less. The argument to wait for the money value to increase applies to the entrepreneur in this case too.
I don't agree that people will go without clean clothes, or food storage today to save a dollar tomorrow. I've thought about cars as well, car costs don't go up year over year, you get more for less value theoretically, why would the price go down?
The view that deflation is bad seems to always henge on a dramatic fall in prices and increase in the dollar value. Inflation doesn't work that way, it is very slow year to year, why would deflation be different?
The bank does not give you a loan, as your business itself does not function as collateral and any capital equipment you bought is worth half as surplus. Instead, they prefer low risk loans that can be turned into zero risk via financial magic.
Furthermore, you only needed the loan in the first place because despite material living expenses being at an all time low, housing rent is at an all time high (thanks to those zero risk loans!) and you do not wish to squander the little savings you have.
Your employer dismisses your idea of working 16 hours a week because it would simply confuse them and there is a long line of people still willing to work 50.
You either keep your day job and forget about your idea, bootstrap while being distracted with a separate consulting business, or set out for the Silicon Valley Casino where you will possibly win 5% of $1B or more likely 5% of $0B.
Your insights make me feel that a deflationary economy might be better
It's a superficially attractive option because who doesn't like stuff getting cheaper? but before long that turns into wage cuts or layoffs because there's less and less money to pay people with.
If you've gotten a house and you're happy where you are you won't have to worry about not being able to afford it in the future.
Sure - deflation is great if you already have all the fixed assets you want and are not dependent on cash flow. If you don't, it's just as bad as runaway inflation. If you have debt, it's a lot worse.
> the reason mildly inflationary economies are commonly preferred by most governments is that, on the balance, it optimizes incentives to maximize real investment
(Yes, the economy runs "hotter" with more risky investments, and more activity in general. Is this actually what we want while simultaneously talking about conserving energy? Also, inflation allows the government to implement a huge hidden tax, fund activities without a fiscal check, and directly distribute that money to government-connected private entities. I couldn't let this perverse incentive become obscured by a faulty implicit assumption that governments optimize for the interests of their citizens - I realize it was not your main point.)
When talking about economic affects on individuals, the problem with investing is it is only an option available to the upper class. Investing requires time and applied intelligence, otherwise it's called gambling. Furthermore, investments have a large overhead to deposit/withdraw.
The poor don't care about inflation, since incoming==outgoing. And the rich don't care much since managing investment is worthwhile, and their inflating liquid assets are a smaller fraction of their wealth.
These problems hit the middle class - they do not have enough savings to make it worthwhile to manage the investment (blindly throwing money at the Wall Street Casino is not investing), so they lose out. In order to have economic bargaining power, they need to keep a relatively larger chunk in liquid cash, which gets eaten away at a disproportionate rate.
So they're forced to choose between the two suboptimal strategies - act poor, spend all of their income, and enjoy their life in the present (while never gaining economic bargaining power to negotiate more favorably with their employer). Or to save, pretending to invest while giving their gains away to professional managers, and feeling poor the entire time as any wealth is illiquid.
Let me speak for the middle class that I am here :-)
For the most part I feel that my investment opportunities are similar to people a lot wealthier than me. Investment costs are way down than what they used to be and there are a lot of options that once weren't available to the average investor.
What's killing me is the low rates which are mostly a function of near zero inflation in the US. If I were in the US I would have almost certainly been invested in housing right now but being in Canada where house prices kept going up this is not a realistic option. Stocks are crazy expensive and super risky. Real estate is super expensive and risky. Bond yields are a joke.
Just give me the "standard" inflation/yields back!
The problem though is that without an increase in "consumption" (either individual or as infrastructure) we're stuck in this cycle. If there's no buyers the economy is slow, prices stay down and yields are down. QE/low yields have pumped up the stock market and maybe housing (at least in Canada it did for sure) but it remains to be seen where this money is going. Some of it must be pumped into the economy but it hasn't been enough yet to make a big difference. We'll see how it goes...
This is NOT why deflation is bad. If there is a deflation rate D and (nominal) interest rates R, you can still get a real return of D+R by investing your money. If you want "risk free" income, you can put your money into AAA fixed income just like you would do in an inflationary economy.
The effects on the allocation of investment in a deflationary world are mathematically identical to an increase in interest rates. I.e., D=0, R=5 is the same as D=2, R=3.
The only notable economic effect is that black money can now earn interest (it's hard to invest black money in fixed income or other such things).
[edit: "Black money" is Hinglish for un-laundered money, i.e. cash profits from crime.]
The problem with deflation is nominal rigidities, i.e. sticky nominal wages or the prideful worker effect. Namely, workers will irrationally refuse to accept work below their previous nominal wage. People's real productivity fluctuates, and sometimes goes down. In an inflationary economy, you can wait a little and not give them pay raises until their real wage drops below their real productivity.
In a deflationary economy, the problem gets worse over time. Hence you'll need to fire the workers with wage > productivity, and those workers will refuse to accept new employment since new offers will have lower nominal wages than their previous job.
But over the last while we've had negative nominal interest rates. This is impossible in a deflationary environment and so one problem in a deflationary environment is that the central banks can't use things like QE or lower interest rates to stimulate spending or investment.
The other thing is that from a behavioral/psychological perspective having an inflation of 1.5% with interest rates at 2% doesn't feel the same as having an interest rate of 0% with a deflation of 0.5%. In the latter people are probably going to be spending less/waiting for prices to come down.
[EDIT: Your salary example is the same effect. It's basically loss aversion. Either loss of income when your salary is decreased or loss of $ when paying more for something today than it will cost tomorrow. The fact that your salary reduction may be less than deflation or that what you're paying is more than if you'd invest doesn't matter to the way our minds treat loss, unless we try to trick it]
QE does not fail when interest rates are zero. Further, there are a variety of tools the central bank can use besides interest rate manipulation. See the blog of Scott Sumner - he covers this in extensive detail.
From a behavioral/psychological perspective, interest rates seem more likely to affect consumption choices. All of Keynesian and monetarist economics is predicated on the idea that people are ignorant of real prices and focus on nominal prices. So 2% nominal interest - 0.5% inflation looks like a 2% rate of return (invest more!) whereas 0% interest + 0.5% deflation looks like a 0% rate of return (consume more!).
[edit: the salary example is NOT loss aversion. If you lose your job for $100, and turn down a job paying $90, you "lose" $100. If you accept the job you "lose" $10.]
Scott Sumner is wrong about the impact of QE. Read Winterspeak and Warren Mosler. Or just use simple logic. How does QE improve the balance sheet of the average person? All it does is swap one piece of government paper for another piece. If my balance sheet is not improved, why would I spend more money and drive up the prices of goods? QE does lower interest rates. If lending is limited by interest rates, than QE could increasing lending. But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact.
As long as interest rates are above 0% QE pumps money into the system. If you bought a 10% yield 10-year bond last year and that yield went to 0% it means you can sell that bond today for the same price you'd get in maturity. So that's a pretty good deal. The government or the central bankers are basically giving free money to bond holders on the assumption they will go use that money to stimulate the real economy. I think the last few years prove that it works to some degree but definitely a lot of that money gets stuck in various places, e.g. the banks.
During QE the central bank can also acquire other assets that are riskier than bonds and take risk off other people's balance sheet, again hoping that money will be used to stimulate the real economy.
At 0% it pretty much stops working. Up to 0% some bond holders are still holding on because they are betting on that being the better investment. The other problem is how do you exit QE. We're going to find out how that works over the next few years...
QE pumps money into the system, but in exchange removes something that's very nearly money. I honestly have no clue as to the overall size of the effect - really big X times a really small y could wind up just about anywhere.
QE is not intended to "improve the balance sheet of the average person". I have no idea why you think it should.
But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact.
You are correct - at a certain point there are no investments with a positive real rate of return. At this point all further resources should be devoted to consumption regardless of time preferences (interest rates). If consumption desires are also completely satisfied, then you are in a post-scarcity economy.
Almost by definition [1], when you reach that point, you are NOT in a recession.
What's the relevance?
[1] The technical definition of a recession is 2 quarters of negative growth, but for theoretical purposes it generally means a period when real resources are not fully utilized.
The purpose of QE is to create inflation. Inflation means that prices of goods and labor go up. The only reason prices go up is if consumers or employers bid up prices. What has never been explained in a satisfying way to me, is how QE results in consumers or employers deciding to bid up the price of goods, in a situation where interest rates are not the limiting reagent in lending decisions at the margin.
At a certain point there are no investments with a positive real rate of return. If consumption desires are also completely satisfied, then you are in a post-scarcity economy. Almost by definition [1], when you reach that point, you are NOT in a recession.
You don't have to be in a post-scarcity economy to have no lending opportunities at the margin. It is also very possible to have no additional lending opportunities, at any positive interest rate during a recession. This is especially so with the way that capital requirements work. If a bank doesn't have adequate capital ratios, they cannot lend, no matter what the rates.
Once bonds yield 0% in a deflationary environment why would anyone hold on to bonds vs. cash? So QE means the government buys it's own bonds and that's about it. I'm talking about the long term rates, not the inter-day rates. Japan has sort of been in this situation and I think they even tried giving money to people and that didn't spur inflation/consumption.
The salary loss aversion I'm talking about is taking a 10% pay cut in a deflationary environment vs. not getting a raise in a zero inflation environment or getting a raise smaller than inflation in an inflationary environment.
The pay cut is going to feel much worse. That's loss aversion. From my exposure to behavioral economics through Dan Arieli I'd say the real loss of $1 is going to feel a lot worse than the nominal loss of $1 eroded by inflation. The latter feels like nothing which is why governments can use inflation as a tool so effectively. The imagery of high inflation is of people rushing with their bags of money to spend it before it becomes worthless... I've lived through some periods of high inflation and when interest rates were at over 10% I don't recall people rushing to invest, they rush to spend...
If the interest rate was below the inflation rate, then you're in a negative real interest rate environment and the rational thing to do is to spend. If the interest rate is above the inflation rate then the rational thing to do is invest. At least with whatever discretionary income you have. If the real interest rate (not the nominal one) is over 10% you can double your money in about 7 years, which is a fantastic proposition.
No bonds are free of risk. Further deflation can be extremely high with real world examples hitting 50% per year. Remember at 50% deflation your zero risk cash is makeing an effective 100% ROI. So those AAA bonds need to make an effective 100+% ROI or there going to default and nobody with a true AAA raiting is going to pay that kind of interest. Worse places that had a AAA raiting often fail in those kinds of shocks.
PS: Basically, the root cause of that kind of deflation is rolling defaults contracting the money supply.
If you have a bond which costs $100 and pays $101 in a year's time, and a 50% deflation rate, then the real return on the bond is 102%. The real return on cash is 100%.
Inflation or deflation with magnitudes exceeding 20-30% is generally a very bad thing, and is also not what the article is discussing.
The problem with deflation is nominal rigidities, i.e. sticky nominal wages or the prideful worker effect. Hence you'll need to fire the workers with wage > productivity, and those workers will refuse to accept new employment since new offers will have lower nominal wages than their previous job.
Contra mainstream academic economics, sticky wages are not actually the main reason deflation causes unemployment during recessions.
A sharp, unexpected deflation causes unemployment because of the non-neutrality of money. When deflation occurs, people first stop buying durable goods like cars or new homes or architectural blueprints. The reason workers get fired is because there is simply nothing for them to produce, because they are not worth being employed at even zero dollars. Many workers are quite willing to pay cuts in hard times, but get fired anyway because there is a glut of inventory and lack of buyers, so they are not worth employing at any price. You'll absurd that in a deflationary recessionary it's the workers in industries where spending is easy to cut that get hit the hardest.
Also, is also when wages are deflating or balance sheets are deflating that this is a problem. If nominal wages are steady, but the prices of goods are gradually decreasing due to technology driven productivity increases, then there will be no general ill effect on unemployment.
Why would a sharp, unexpected deflation cause people to stop buying durable goods?
Concretely: One day, the price of everything has dropped 10%. After that day, things return to normal. Why would I not buy a new laptop? I'd feel bad if I bought one before the drop, but that's a different matter.
This is also quite unrelated to the article which discusses consistent and expected low deflation rates.
Many workers are quite willing to pay cuts in hard times, but get fired anyway because there is a glut of inventory and lack of buyers, so they are not worth employing at any price.
This is clearly not true. During the entire recession, I was happy to pay people $5.15 or even $7.25/hour to clean my house. Yet maids cost far more than that.
In any case, your claim that workers are fired because they have nothing to produce is the ZMP (Zero Marginal Productivity) theory. This falls into PSST/Austrian/Structuralist theories and is quite outside the purview of monetary economics. If a worker has zero real productivity, they will be unemployed regardless of monetary conditions.
But deflation and inflation don't work like that. It's not a sudden drop or a sudden rise after which we magically reset. It's a process. Another way of saying that is that what matters is not the price right now or the price yesterday but the price expectations and the feedback loop.
There's lot of questions to ask about your $5.15 sample there. Were there maids out of work? What would have been the cost for those maids to go and clean your house? What's their alternative? In truly tough economical times pretty much any job at any salary was filled. We should be happy we weren't there.
As to why people lose their jobs in a deflationary environment I guess it's probably not one single reason but if the economy is doing poorly companies will adjust by reducing their expenses. Whether a single person is laid off because he has nothing to do or 10% of the workforce is laid off because sales are down 10% is pretty much the same thing, no? The point though is that job loss is a more likely outcome then salary reduction, at least I think so, not unlike a recession during an inflationary environment...
But deflation and inflation don't work like that. It's not a sudden drop or a sudden rise after which we magically reset. It's a process.
I'm only responding to bokonist's hypothetical, which is also not what the article is about (slow and steady deflation).
There's lot of questions to ask about your $5.15 sample there. Were there maids out of work?
There were lots of unemployed people during the recession who could have cleaned houses. I don't know why you think someone previously employed as an HR exec for $100k is incapable of cleaning houses at minimum wage.
The purpose of inflation is that in your hypothetical where a company needs to reduce employee costs by 10%, the company can sneakily hold wages fixed and allow the wages to inflate away. This gets around the prideful worker reactions to having their nominal wage cut.
I mean a sharp, unexpected deflation as it actually happens in the real world. In the real world, deflation starts with either a collapsing debt or asset bubble. Bank runs wipe out deposits, a housing bubble bursts, the stock market crashes, etc. Suddenly people realize they are not as rich as they thought they were. A university endowment realizes it has just fallen by 20%. So everyone cuts spending. The easiest thing to cut is stuff like buying cars or designing new buildings or new construction projects. So when the endowments fell, two-thirds of the architects in Boston got laid off, because the construction projects all stalled and there was no work for them to do. Autoworkers got laid off because people held off on buying cars. Etc. etc.
The big, #1 reason investment is bad during deflation is a topic that should interest a lot of the readers of this site, and indeed, YCombinator itself: it is impossible to sell manufactured goods in a deflationary economy at a profit.
The problem exists any place there is a latency between when you buy your starting materials and when you sell the final product. In a normal (break-even or mildly inflationary economy) you start with capital that has some amount of value (purchasing power). Time passes as you make the product, and you can sell it at an equal or greater (profit margin) amount which allows you to regain your initial capital investment.
That completely breaks in deflation. The value of the money rises ,and yes, this means people are slightly less likely to spend it, but the problem comes when you want to sell your product. Say you invested $100 to make a product with the expectation being able to sell at a 50% profit margin. Except during the time it took to you to make it, money deflated, and the purchasing price of those same starting materials is now $50. Adding in the same 50% profit says your now can only sell your product at $75.
The deflation that happens between investing and selling not only eats your profit margin, it can easily eat your ability to recover your initial capital. Investment is ludicrous in an environment like that.
So we go with the "worst method possible, except for all the rest": mild inflation that is hopefully small, manageable, and trivial.
Anyone who is worried about deflation in the US right now is a moron. We printed (we actually don't even bother printing it we just change numbers in a database) more money since 2008 than in the entire history of the country. The Fed owns over a quarter of the whole bond market. http://www.forbes.com/sites/robertlenzner/2013/11/25/the-fed...
And yet inflation has barely cracked 3% since the proverbial printing presses started up, and has bounced around at <2% for the past few years. Hence the cause for concern: we pulled an unprecedented amount of currency out of thin air, and the result was below average inflation.
>You're of course referring to the current bogus CPI, which was put into effect in the 1990s to hide the real rate of inflation.
Let's just assume this is true. CPI, as currently measured, has been in place since ~1996. One can thus safely assume CPI would reflect the alleged inflationary effects of QE on price levels, regardless of how accurately it measures the actual rate of inflation, since it represents a measurement of some consistent snapshot of the total rate of inflation throughout the entirety of QE.
But CPI shows no change in the rate of inflation due to QE, and even more curiously, tells us inflation is currently lower now than pre-QE. Regardless of your opinion of its measurement of "real" inflation, the fact remains: there has been no uptick in price levels due to QE (startup valuations aside, hah!), despite the intuition that it ought to have resulted in substantial inflation. Hence, cause for concern.
EDIT: And I say all of this as someone who was horrified of inflation back when the Fed first started QE. So far, I appear to have been worried about the wrong thing.
The whole QE program MUST be inflationary. It don't make any rational sense that a government could just purchase trillions of dollars worth of it's own debt with synthetic money and not have some inflationary impact (your initial fear). So what then? How is that massive force just being absorbed with no consequence? I don't know, I don't think anyone knows. I could speculate. It's likely that in a global economy China's artificially devalued currency allows us to print money without real inflationary consequences for us? Could be the dollar has become the de facto world currency and with this much wider circulation the system can absorb much more inflationary pressure than previously thought. Could be that this system is controlled more by behavioral economics than economics. Maybe people just believe a dollar is worth about X and that's very sticky until it isn't. This last idea is the scariest. Our government is just like a big bank. The value of the dollar is subjective and I believe serious inflation won't come in an incremental fashion, it will come in a black swan tidal wave. I could be wrong and I seriously hope I am!! I just don't think it's prudent to say, well we all thought (rationally and rightly) QE was going to cause inflation because it's so obviously an aggressively inflationary policy... then since it didn't we just turn the page and say oh well... glad that didn't blow up the dollar. We need to understand why that didn't have an effect.
Not sure why the above statement was downvoted.
The three major expense areas in every family's life:
- housing (the rates depend on the market)
- health care (12-15%/year)
- college tuition (5-8%/year, perhaps a bit lower recently)
have been inflating at a rate far greater than the official CPI rate for quite a few years now. The declining price of big screen TVs cannot offset the above.
The problem with deflation is that, if you're trying to control the money supply, and your control is based on printing money, and you have deflation, you lose control. The figurative "pushing on a string," you have nothing left to leverage. You can't go below 0.
It's really more of a power/control issue than anything. The _entire point_ of centralized banking is to _cause_ inflation, just not enough that it becomes an issue.
Are you really that proud of the status quo? lets see, we'll take a bunch of bank acounts, pay zero interest, and only let rich people & corporations borrow without abandon to finance their acquisition (er, corner) the market in all real-assets? Sounds like a great plan if your biz modle if f(n)% of asset inflation.
Pointing out that deflation is a bad is not necessarily a statement of support for any aspect of the current system. Staying away from deflation is good; the other parts are another matter and need fixing in several ways.
deflation is a bad is a hypothetical, and the arguments for and against are not trivially dismissed. your trading book matters more than any theory. since the analysis is so fact depenedent, there is no simple right answer.
Deflation is only bad for fixed interest rate debt bearer. Adjustable interest rate debt goes lower along with deflation. The only problem for adjustable rate is that it can't go lower when interest rate reaches 0 and deflation rate keeps going down. To fix that, allows interest rate to go negative. That means the principal of the debt goes down faster.
If everything is floating down with deflation, it's not too bad. For the fixed rate debtors, well they made a calculated risk that inflation will go up.
88 comments
[ 3.0 ms ] story [ 147 ms ] threadWhere is it, who, exactly, does this hurt. Who will be sitting on their money, waiting to buy things they need until tomorrow. Only people who already have everything they need, and even then they will continue to buy the basics. Who does this hurt. The roads will continue to be paved, the cities will continue to function. How does this all break down when a dollar today is worth a dollar and a fraction of a cent tomorrow.
We weren't all dying when gas was $1 a gallon were we?
That's who.
Only until prices fall enough that people start spending again and hiring picks up again.
The idea of an evenly rotating economy where everything is great all the time has been thoroughly disproven over 100 years ago. To try and manage the economy to be so is a fool's errand.
Debt has grown ever-so-slightly faster than income for the last 40-50 years and that means future purchases have been pulled to the present for the last 40-50 years. If history is a guide (and I believe that it is) one of two things will happen:
1. People will start to pay down their debt and this will unfortunately result in hardship as debt-fueled growth stops
2. The banks will print more money and the party never stops until the party blows up in an enormous currency crisis
I can't tell you which will happen, but every time we print more money we grow the systemic risk of total blowup. People who argue that we should be doing more to prevent climate change while simultaneously cheering money-printing need to take a good look at their belief systems.
But why would I bother investing capital to hire people to make stuff if I've got guaranteed returns just by sitting on cash?
It used to be that prices went up, then down, then back up again, then back down again, etc on a time-scale of a couple of years. Maybe spanning a range of 4x or so. Because everyone knew that's how things went, they arranged their affairs to cope and things weren't amazing, but a year or two of deflation didn't destroy the world.
What we have now are huge asset bubbles that are popping and people at the Fed are trying to reflate and/or at least slow the collapse down. The problem isn't that deflation might happen; it's that there were years and years of asset prices going to more and more unreasonable levels that no sane person would pay.
How do you clean the slate and get asset prices back to levels that might make sense from a fundamentals perspective instead of a risk-on, risk-off perspective? The only thing I can think of is to let them fall to levels where people would be willing to buy them again. It's either that or a 20 year inflationary slog to slowly reprice them in real terms.
In other words, at 4% inflation over 20 years if a price doesn't change in nominal terms it'll lose 55% of its value in real terms. That roughly approximates it dropping in value 50% in say 6 months nominally, because in 6 months nominal terms are unlikely to diverge from real terms by more than a few percent.
Which would you rather have? 20 year of Japan or the Great Depression, or a fairly swift realignment of the economy to the new realities? Either way the assets have to get repriced once everyone realized that they were priced horribly, horribly incorrectly.
That less money means you have more surplus money to spend on luxuries. More people will have more disposable income, which likely would mean they buy more goods, and could sustain a larger economy... leading to economic growth.
Plus-- the goods you're buying are made by companies who are buying materials at a lower cost, and thus if they lower prices slower than the materials prices are going down due to inflation they have more margin.
Businesses as well will have more flexibility, the ones that are borderline now will last longer, might turn things around, etc.
Meanwhile my savings are slowly growing in economic power, even though all I've done is stuff them in an old mattress.
New entrants to the labour market can never aspire to have the kind of cash their older peers have put away because work yesterday is valued more than work today.
Not a world I want to live in.
It'll likely also hurt some countries that have accumulated far more debt than they could ever reasonably hope to pay back. Debt also motivated by the same entities hoping to make a buck from nothing.
I'm not at all afraid. I have no debt and I invest in things that have actual value when used, like real estate. I don't care if prices drop, because it'll still be real estate with practical value.
Once something is expensive enough that say, 95% of the population has to finance it, the purchase price is no longer really a consideration. Sure you might sign on a mortgage that ostensibly says you start out owing $300k or whatever, but in reality what you're signing on is an obligation to pay $2k/month for the next 30 years, or until you sell it, go broke and move out, etc.
At 10% interest the $2k/mo doesn't have all that large of a price-artifact; it's about $200k. At 4% interest, the $2k/mo price-artifact is $375k. This is interesting and serves to illustrate that lowering the interest rate doesn't really "help" real-estate except to ensure that people aren't underwater in houses they paid too much for.
In the non-financing world, a high interest rate means that you get a future-discount by saving your money and buying it later. And a low interest rate means that you get less of a future-discount by waiting to buy. When I say "a high interest rate" I'm talking about the real interest rate, interest minus inflation. The nominal interest rate doesn't matter save for some psychological effects. You can get that by having 10% interest and 4% inflation or 2% interest and 4% deflation, either way the real interest rate is 6%. But when the interest rate is 1% and inflation is 3% then the real interest rate is negative, -2% and you're a fool to save any money at all; everything else equal. This is how lowering the interest rate pulls future purchases into the present.
Here's the kicker though: eventually there's less and less future purchases to pull from, and as a result the inflation has to get ever-more severe. As you start to approach spending all your money on debt service, you have less and less ability to take on new debt. And that means that the terms have to get substantially more favorable, and seemingly the only way to do that is to inflate enough to make the old debt less burdensome. Is that an underhanded form of theft? Probably, but it's the legal kind.
The "hoarding" argument tends to fall apart if you consider all the things which a person HAS to buy; food, water, clothing, shelter, energy, transportation, etc. It's not as though you can not eat your vegetables because they're expensive for 20 years and then make up for that all at once. Can people make do with less? Sure.
One person's "hoarding" is another person's ability to finance a house because the bank has enough savings to make the loan.
My math is no doubt horribly off, but if each $1 is worth more that the end of the loan, deflation, or if I'm instead paying out more than $1 per month at the end of the loan, inflation, why is the deflated $1 worth less in a relative world view.
Is the interest lost from inflation equal the value gained from deflation?
So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff.
If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc).
That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not.
The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly.
I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.
No. Think about what happens to any large organization during deflation.
The counterintuitive part here is that every large organisation, including the government, is worth exactly nothing. Now you might think "But Obama sure has a nice little white house, lots of employees, ... that's gotta be worth something". That's true. Those are the assets. Then you have the liabilities. This includes loans that need to be repaid (plus interest), and any remaining capital is effectively loaned to the shareholders (though in practice this will, nearly always, be zero. The exceptions are Apple, Google and Facebook, but there's other major caveats there).
Now what happens when you have 11% deflation (making an extreme example, nobody's expecting more than 1.1% at the moment).
Before:
* Assets(t-1) = What was produced (sold) - what was consumed (yes, even for the government)
* Liabilities(t-1) = What was loaned
* Worth(t-1) = Assets(t-1) + Liabilities(t-1) = 0
After 11% inflation:
* Assets(t) = 0.9 * What was produced (sold) - 0.9 * what was consumed
* <> Assets(t) = 0.9 * Assets(t-1)
* Liabilities(t) = What was loaned ~= Liabilities(t-1)
(Liabilities, especially loans, but many other instruments as well, are not affected by inflation)
* Worth(t) = 0.9 * Assets(t-1) + Liabilities = Worth(t-1) - 0.1 * Liabilities(t-1)
So there you have it : the organisation (say, the US government), effectively has to pay 10% of it's liabilities without getting anything in return for that. Zero liabilities disappear, nothing gets produced, it's literally money down a black hole. So there you have (way, way oversimplified) the problem. When you have deflation, every organisation that is balanced (assets + liabilities = zero), including the government, every large organisation, ... all their loans effectively increase by the deflation amount.
So what would the effect be of 1% deflation :
The US government loaned $17 trillion, so every 1% of deflation means raising tax income by 170 billion (or loaning it, worsening the problem quickly) without getting anything in return at all.
Note that this is just the primary effect. The fact that every loan suddenly becomes more expensive to repay will have all sorts of indirect effects, like say a housing price crash (because banks can be pretty sure nobody will be able to repay even small loans with low interest rates).
Deflation, effectively, is a tax on loans. It will very quickly destroy anyone and anything holding loans, which is to say everyone. Incidentally, fractional reserve banks have a capital buffer of 2%, which means they loan out 50 times more money than they have in capital, all of which will suddenly and simultaneously have problems getting repaid. What do you think will happen to your savings ?
Cynics would say, because the effect this will have on governments, they will go to war. Especially the ones that don't control their own currencies.
(in other words, a piece of advice : if inflation gets to 0%, you won't get interest on the bank anyway. Get your money and hide it under your mattress before everyone else does)
So, if I thought the rate of return made sense, I could borrow dollars on my credit card, buy Apple, Google or Facebook stock, and then pay back the loan on the dividends or returns from the stocks appreciation. This isn't even necessarily irresponsible if, say, you bought Berkshire Hathaway, which has historically returned >%20. If it continues to do so, even a credit card rate of %13 will give you a %7 spread.
This is a simple example of leverage and is effectively the same as trading stock on margin.
But, I'm sure everyone reading this realizes the danger- Buffet may die, BRK might flatten, any of those tech companies might not return what I expect.
That's the risk of leverage.
So, in short, inflation incentivizes the risk of leverage.
And that's exactly what we saw in the housing bubble where people with $60k in income were buying 4-5 $120k condos hoping to flip them in a few years.
But leverage is also the thing that allows me to buy a house or a car on credit rather than outright with cash.
Leverage is kind-of like guns. I want me to have it because I'm responsible and can handle it appropriately. But I'm not sure that anyone else should be allowed to have it.
(I'm personally for arming people more rather than less, but it seems like it'll hit home for a lot of folks)
One of the many psychological toys the Fed & Co. use, just like they regularly threaten to raise interest rates (for years at this point) to buy more time on holding down the bubbles they've created without having to actually do anything.
The reason so many people are afraid of deflation, is they're from the Keynesian school of economics. They've been brainwashed for two generations to think inflation is how you grow an economy. No coincidence, the Keynesian experiment has been a global disaster of epic proportions, leading to the greatest accumulation of debt in world history; and locally, a 40 year stagnation in the American standard of living, perpetually high real unemployment, increased poverty, and increased inequality (because the rich can shield themselves from inflation, the poor cannot).
Every country in history that has ever attempted to implement a Keynesian inflation based economy, has failed, with the result being a disaster. Such examples include the US, Japan, much of Europe and lately China has signed on to the debt / stimulus / inflation party. Japan is a famous, fake deflation example. They haven't suffered a penny of deflation in 30 years (an inflation based asset bubble imploding, is not deflation); if Japan had suffered decades of deflation, their wages and prices wouldn't be among the highest in the world.
What colour is the sky on your planet?
The myth that inflation is good is one of the greatest lies used to pervert a seemingly free society into yet another treadmill of sustenance-based slavery.
In a functioning free market economy, most prices should be always decreasing - that is precisely what competition is based on!
But when we fix the CPI, what we get instead is basic necessities still being optimized ever-lower, while the currency is inflated to make energy costs (the only true monetary measure) rise to compensate. Collateralizable assets shoot through the roof as they're used to facilitate the monetary inflation (those who control access to the proverbial printing press taking a hearty cut), and we get to our current point where things that used to be owned are now just rented from banks.
Ask yourself how many people have avoided owning a computer, knowing that prices are always dropping? How many people have gone hungry, figuring that food will be cheaper next week?
Yes, I completely agree with this. I just don't think that it's bad. At a certain point, the utility of having the good today surpasses any additional utility that could be achieved by delaying the purchase.
The balance shifts back towards consumption as people build wealth, since the utility of saving decreases. Rather than being encouraged to quickly spend income on goods, saving wealth to spend at any time allows one to plan their purchases and better negotiate for the value of their time.
If you wait a little longer, you can buy a better tablet, a better computer, a better phone, a better TV with the same amount of money (inflation-corrected or not). That doesn't stop people from buying all kinds of electronic devices, even though they get obsolete much faster than their money.
I believe it is not perverse because saving allows for investing, and is the basis of capitalism- the accumulation of capital that can be deployed productively.
Even if you're just saving on the downpayment of a house- putting %20 vs %10 can save a whole lot of money on a 30 year mortgage, leaving you better off in retirement, etc.
The argument that there needs to be inflationary bias to create jobs is weak on many levels. This is just one.
During an inflationary credit expansion, wealth is transferred from the public in general to the earliest recipients of the newly created credit money. In practice, the earliest recipients are interest groups with the strongest political connections to the state and, in particular, the state institutions that control monetary policy (i.e., the Federal Reserve in the United States). Importantly, the wealth transfer that takes place during an inflation is hidden and largely unrecognized by the majority of the population. The population is unaware that the supply of money is increasing and the attendant rise in prices, ostensibly beneficial to business, initially
"produces [a] general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply — all is saleable and everybody can continue what he had been doing." In an inflationary environment, wealth transfer proceeds insidiously and is masked by a perceived prosperity. The unmasking finally occurs at the end of the credit boom when the market's tendency to clear prior losses takes hold. Failed businesses are liquidated and their capital is transferred, usually through bankruptcy, to creditors who must acknowledge losses on these misguided investments. Unemployment soars and social unrest replaces the former sense of euphoria attending the credit boom. Professor Hülsmann summarizes the differences between the transfers of wealth occurring under inflation and deflation as such:
"In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. It entails visible misery for many people, to the benefit of equally visible winners. This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers. … [Inflation] is a secret rip-off and thus the perfect vehicle for the exploitation of a population through its (false) elites, whereas deflation means open redistribution through bankruptcy according to the law."
And here lies the answer to why the state prefers a policy of controlled inflation. Only in an inflationary environment can state largesse be conferred to the politically well-connected without raising public ire. The widespread and visible transfers of property through bankruptcy that must take place during a deflation are often politically destabilizing and thus highly unappealing to any regime. A sense of injustice grows within the population as banks are saved from the folly of their misguided investments with taxpayer-funded bailouts, while debtors with no political clout have property seized in bankruptcy.
* http://mises.org/daily/4974/The-Politics-of-Deflation
It is effectively like cash earning tax-free interest. And since it is cash, that "investment" is virtually risk-free because you'll always have the cash.
As a consequence, simply holding cash starts competing with the expected return of investing the cash in other ways, like real estate, government bonds, the stock market, or a startup. Relative to some traditional investments, you might maximize your effective risk-adjusted returns by doing nothing at all!
This sounds great (at least for people with cash) until you realize that this "investment" is one of the least productive investments possible. No infrastructure is built, no technologies invented, no products are created for customers. While people with cash might be nominally wealthier, there is greatly reduced investment of cash in things that improve the productivity and wealth of the entire economy.
Furthermore, real investment is how many jobs are created. Several million jobs in the United States are paid for with funds from speculative investments. If it no longer pays to make speculative investments on new technologies, new startups, or otherwise changing the world, what do you think happens to those jobs that are tacitly funded by that investment?
Mild inflation, for better or worse, incentivizes anyone with a bit of money to use that money to fund companies, infrastructure, technology, and jobs that may ultimately return higher value than the loss to inflation. Yes, if you sit on your cash in an inflationary economy, you slowly lose wealth. It incentivizes people to attempt to apply their assets toward productive ends.
Lastly, there is the question of what about people with little or no cash in an inflationary environment? On the surface, it looks like they get screwed. In practice, the productivity and technology advances created by the investment by people with money are often effectively neutral or deflationary. Not only are they more productive at their jobs, assuming they have one, but the costs of many goods decline thanks to the investment. This doesn't apply to all goods but it applies to many that almost everyone consumes. That said, if an economy inflates too fast it can quickly outstrip the earning potential of the people that operate in it. The flow of money through an economy has a significant viscosity and in extreme cases that causes much suffering.
In summary, the reason mildly inflationary economies are commonly preferred by most governments is that, on the balance, it optimizes incentives to maximize real investment which not only grows the economy in real terms but has quasi-deflationary effects for consumers as well. There are always tradeoffs but this is widely believed to have the "least bad" set of tradeoffs for a currency inflation/deflation policy.
If money is "hidden under blankets" it is taken out of circulation. The value per unit currency still in circulation increases (due to lack of supply) and this will boost the purchasing power of the money remaining in circulation. For this reason the idea that "deflation causes a liquidity crisis" is a bit misleading- It causes a liquidity crises measured in "face value" but not in "purchasing power" of the currency. (Though some of your prognoses are probably still true but occur because of other, somewhat different mechanisms)
One other point: inflation is actually beneficial to people who are in debt[0], as it reduces the real value of their debt. (In other words, the dollar that they use to pay off the debt a year from now is worth less than the dollar today, so inflation literally allows them to use less money[1] to pay off their debt).
Conversely, deflation is terrible for people who are in debt, as it effectively increases the amount of money they have to spend to pay off the debt (this is on top of the compounding interest; it is looking at the real value of the same nominal dollar amount).
So, one of the biggest dangers of deflation is that it harms people with negative net worth (people deeply in debt)[2].
[0] Assuming fixed interest rates
[1] In real terms, not nominal terms
[2] The people who 'win' in this particular context are the people who own that debt (ie, the bankers). But as jandrewrodgers pointed out, there are a number of other ways that deflation harms them as well, so deflation is really a lose-lose situation.
If the inflation is expected, interest rates adjust accordingly. India has roughly a 10% inflation rate and interest rates on mortgages tend to be 11-12%. The US has inflation rates of about 1-2% and mortgage rates of 3-4%.
tl;dr; If inflation is I, you'll be paying interest rates of I+R where R is dependent on availability of capital, your risk factors, etc.
Your insights make me feel that a deflationary economy might be better, we're always running, rushing, we can't stop, we have to work harder all the time. To not move forward is to make less money, to be able to not afford this year what you could last year because the peg is always moving. A deflationary environment still rewards workers, because the dollars are worth more, but doesn't punish you for not constantly struggling. If you've gotten a house and you're happy where you are you won't have to worry about not being able to afford it in the future. Without being able to get into debt we would be forced to learn good saving habits.
In this inflationary environment, with a limited savings and limited ability to invest my value is constantly going down no matter how hard I work or how much I learn I am worth less every day than I was the day before. My minutes are worth less, my hours, my free time is worthless now. If you don't job hop, stay in one spot, if you made $100k as a software dev in the 90s, which wasn't out of the question, and you still make $100k now, you're making a whole lot less money.
It's true you get a small raise each year. But from the business owner's perspective, their costs go up each year. The salary stays the same number but you're paying them more. As you can charge less for your products (deflation means prices fall), you get less money to pay your employee with. So how do you stay in business?
And your employees find it hard to leave because other companies can't match their salary. So it hurts the flexibility of labor to move to more suitable jobs. The result is a stifling and suffocating business environment. Many companies go out of business during deflation.
And flip the coin, you are a bank with cash in your vault which is basically the depositors money.
Now as the bank your deposits become more valuable by doing nothing, than they do by lending them out to the entrepreneur to start his business. So you go with the 'safe' choice, you sit on the money.
The Entrepreneur either can't get a loan, or has to pay an extortionate interest rate because the bank doesn't care, if they don't lend they win.
People stop buying large purchases like dryers or refrigerators because if they just wait long enough the price will come down and they can get a much better refrigerator for their money. So large appliances and other large investments (cars for example) sit unsold, that idles factory workers since there is plenty of stock in the market place. So they get laid off.
Deflation has the effect of contracting the economy, modest inflation tends to expand it.
I don't agree that people will go without clean clothes, or food storage today to save a dollar tomorrow. I've thought about cars as well, car costs don't go up year over year, you get more for less value theoretically, why would the price go down?
The view that deflation is bad seems to always henge on a dramatic fall in prices and increase in the dollar value. Inflation doesn't work that way, it is very slow year to year, why would deflation be different?
Furthermore, you only needed the loan in the first place because despite material living expenses being at an all time low, housing rent is at an all time high (thanks to those zero risk loans!) and you do not wish to squander the little savings you have.
Your employer dismisses your idea of working 16 hours a week because it would simply confuse them and there is a long line of people still willing to work 50.
You either keep your day job and forget about your idea, bootstrap while being distracted with a separate consulting business, or set out for the Silicon Valley Casino where you will possibly win 5% of $1B or more likely 5% of $0B.
It's a superficially attractive option because who doesn't like stuff getting cheaper? but before long that turns into wage cuts or layoffs because there's less and less money to pay people with.
If you've gotten a house and you're happy where you are you won't have to worry about not being able to afford it in the future.
Sure - deflation is great if you already have all the fixed assets you want and are not dependent on cash flow. If you don't, it's just as bad as runaway inflation. If you have debt, it's a lot worse.
(Yes, the economy runs "hotter" with more risky investments, and more activity in general. Is this actually what we want while simultaneously talking about conserving energy? Also, inflation allows the government to implement a huge hidden tax, fund activities without a fiscal check, and directly distribute that money to government-connected private entities. I couldn't let this perverse incentive become obscured by a faulty implicit assumption that governments optimize for the interests of their citizens - I realize it was not your main point.)
When talking about economic affects on individuals, the problem with investing is it is only an option available to the upper class. Investing requires time and applied intelligence, otherwise it's called gambling. Furthermore, investments have a large overhead to deposit/withdraw.
The poor don't care about inflation, since incoming==outgoing. And the rich don't care much since managing investment is worthwhile, and their inflating liquid assets are a smaller fraction of their wealth.
These problems hit the middle class - they do not have enough savings to make it worthwhile to manage the investment (blindly throwing money at the Wall Street Casino is not investing), so they lose out. In order to have economic bargaining power, they need to keep a relatively larger chunk in liquid cash, which gets eaten away at a disproportionate rate.
So they're forced to choose between the two suboptimal strategies - act poor, spend all of their income, and enjoy their life in the present (while never gaining economic bargaining power to negotiate more favorably with their employer). Or to save, pretending to invest while giving their gains away to professional managers, and feeling poor the entire time as any wealth is illiquid.
For the most part I feel that my investment opportunities are similar to people a lot wealthier than me. Investment costs are way down than what they used to be and there are a lot of options that once weren't available to the average investor.
What's killing me is the low rates which are mostly a function of near zero inflation in the US. If I were in the US I would have almost certainly been invested in housing right now but being in Canada where house prices kept going up this is not a realistic option. Stocks are crazy expensive and super risky. Real estate is super expensive and risky. Bond yields are a joke.
Just give me the "standard" inflation/yields back!
The problem though is that without an increase in "consumption" (either individual or as infrastructure) we're stuck in this cycle. If there's no buyers the economy is slow, prices stay down and yields are down. QE/low yields have pumped up the stock market and maybe housing (at least in Canada it did for sure) but it remains to be seen where this money is going. Some of it must be pumped into the economy but it hasn't been enough yet to make a big difference. We'll see how it goes...
The effects on the allocation of investment in a deflationary world are mathematically identical to an increase in interest rates. I.e., D=0, R=5 is the same as D=2, R=3.
The only notable economic effect is that black money can now earn interest (it's hard to invest black money in fixed income or other such things).
[edit: "Black money" is Hinglish for un-laundered money, i.e. cash profits from crime.]
The problem with deflation is nominal rigidities, i.e. sticky nominal wages or the prideful worker effect. Namely, workers will irrationally refuse to accept work below their previous nominal wage. People's real productivity fluctuates, and sometimes goes down. In an inflationary economy, you can wait a little and not give them pay raises until their real wage drops below their real productivity.
In a deflationary economy, the problem gets worse over time. Hence you'll need to fire the workers with wage > productivity, and those workers will refuse to accept new employment since new offers will have lower nominal wages than their previous job.
The other thing is that from a behavioral/psychological perspective having an inflation of 1.5% with interest rates at 2% doesn't feel the same as having an interest rate of 0% with a deflation of 0.5%. In the latter people are probably going to be spending less/waiting for prices to come down.
[EDIT: Your salary example is the same effect. It's basically loss aversion. Either loss of income when your salary is decreased or loss of $ when paying more for something today than it will cost tomorrow. The fact that your salary reduction may be less than deflation or that what you're paying is more than if you'd invest doesn't matter to the way our minds treat loss, unless we try to trick it]
http://en.wikipedia.org/wiki/Nominal_income_target
From a behavioral/psychological perspective, interest rates seem more likely to affect consumption choices. All of Keynesian and monetarist economics is predicated on the idea that people are ignorant of real prices and focus on nominal prices. So 2% nominal interest - 0.5% inflation looks like a 2% rate of return (invest more!) whereas 0% interest + 0.5% deflation looks like a 0% rate of return (consume more!).
[edit: the salary example is NOT loss aversion. If you lose your job for $100, and turn down a job paying $90, you "lose" $100. If you accept the job you "lose" $10.]
During QE the central bank can also acquire other assets that are riskier than bonds and take risk off other people's balance sheet, again hoping that money will be used to stimulate the real economy.
At 0% it pretty much stops working. Up to 0% some bond holders are still holding on because they are betting on that being the better investment. The other problem is how do you exit QE. We're going to find out how that works over the next few years...
But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact.
You are correct - at a certain point there are no investments with a positive real rate of return. At this point all further resources should be devoted to consumption regardless of time preferences (interest rates). If consumption desires are also completely satisfied, then you are in a post-scarcity economy.
Almost by definition [1], when you reach that point, you are NOT in a recession.
What's the relevance?
[1] The technical definition of a recession is 2 quarters of negative growth, but for theoretical purposes it generally means a period when real resources are not fully utilized.
At a certain point there are no investments with a positive real rate of return. If consumption desires are also completely satisfied, then you are in a post-scarcity economy. Almost by definition [1], when you reach that point, you are NOT in a recession.
You don't have to be in a post-scarcity economy to have no lending opportunities at the margin. It is also very possible to have no additional lending opportunities, at any positive interest rate during a recession. This is especially so with the way that capital requirements work. If a bank doesn't have adequate capital ratios, they cannot lend, no matter what the rates.
The salary loss aversion I'm talking about is taking a 10% pay cut in a deflationary environment vs. not getting a raise in a zero inflation environment or getting a raise smaller than inflation in an inflationary environment.
The pay cut is going to feel much worse. That's loss aversion. From my exposure to behavioral economics through Dan Arieli I'd say the real loss of $1 is going to feel a lot worse than the nominal loss of $1 eroded by inflation. The latter feels like nothing which is why governments can use inflation as a tool so effectively. The imagery of high inflation is of people rushing with their bags of money to spend it before it becomes worthless... I've lived through some periods of high inflation and when interest rates were at over 10% I don't recall people rushing to invest, they rush to spend...
PS: Basically, the root cause of that kind of deflation is rolling defaults contracting the money supply.
Inflation or deflation with magnitudes exceeding 20-30% is generally a very bad thing, and is also not what the article is discussing.
krugman.blogs.nytimes.com/2010/08/02/why-is-deflation-bad/
Contra mainstream academic economics, sticky wages are not actually the main reason deflation causes unemployment during recessions.
A sharp, unexpected deflation causes unemployment because of the non-neutrality of money. When deflation occurs, people first stop buying durable goods like cars or new homes or architectural blueprints. The reason workers get fired is because there is simply nothing for them to produce, because they are not worth being employed at even zero dollars. Many workers are quite willing to pay cuts in hard times, but get fired anyway because there is a glut of inventory and lack of buyers, so they are not worth employing at any price. You'll absurd that in a deflationary recessionary it's the workers in industries where spending is easy to cut that get hit the hardest.
Also, is also when wages are deflating or balance sheets are deflating that this is a problem. If nominal wages are steady, but the prices of goods are gradually decreasing due to technology driven productivity increases, then there will be no general ill effect on unemployment.
Concretely: One day, the price of everything has dropped 10%. After that day, things return to normal. Why would I not buy a new laptop? I'd feel bad if I bought one before the drop, but that's a different matter.
This is also quite unrelated to the article which discusses consistent and expected low deflation rates.
Many workers are quite willing to pay cuts in hard times, but get fired anyway because there is a glut of inventory and lack of buyers, so they are not worth employing at any price.
This is clearly not true. During the entire recession, I was happy to pay people $5.15 or even $7.25/hour to clean my house. Yet maids cost far more than that.
In any case, your claim that workers are fired because they have nothing to produce is the ZMP (Zero Marginal Productivity) theory. This falls into PSST/Austrian/Structuralist theories and is quite outside the purview of monetary economics. If a worker has zero real productivity, they will be unemployed regardless of monetary conditions.
There's lot of questions to ask about your $5.15 sample there. Were there maids out of work? What would have been the cost for those maids to go and clean your house? What's their alternative? In truly tough economical times pretty much any job at any salary was filled. We should be happy we weren't there.
As to why people lose their jobs in a deflationary environment I guess it's probably not one single reason but if the economy is doing poorly companies will adjust by reducing their expenses. Whether a single person is laid off because he has nothing to do or 10% of the workforce is laid off because sales are down 10% is pretty much the same thing, no? The point though is that job loss is a more likely outcome then salary reduction, at least I think so, not unlike a recession during an inflationary environment...
I'm only responding to bokonist's hypothetical, which is also not what the article is about (slow and steady deflation).
There's lot of questions to ask about your $5.15 sample there. Were there maids out of work?
There were lots of unemployed people during the recession who could have cleaned houses. I don't know why you think someone previously employed as an HR exec for $100k is incapable of cleaning houses at minimum wage.
The purpose of inflation is that in your hypothetical where a company needs to reduce employee costs by 10%, the company can sneakily hold wages fixed and allow the wages to inflate away. This gets around the prideful worker reactions to having their nominal wage cut.
The problem exists any place there is a latency between when you buy your starting materials and when you sell the final product. In a normal (break-even or mildly inflationary economy) you start with capital that has some amount of value (purchasing power). Time passes as you make the product, and you can sell it at an equal or greater (profit margin) amount which allows you to regain your initial capital investment.
That completely breaks in deflation. The value of the money rises ,and yes, this means people are slightly less likely to spend it, but the problem comes when you want to sell your product. Say you invested $100 to make a product with the expectation being able to sell at a 50% profit margin. Except during the time it took to you to make it, money deflated, and the purchasing price of those same starting materials is now $50. Adding in the same 50% profit says your now can only sell your product at $75.
The deflation that happens between investing and selling not only eats your profit margin, it can easily eat your ability to recover your initial capital. Investment is ludicrous in an environment like that.
So we go with the "worst method possible, except for all the rest": mild inflation that is hopefully small, manageable, and trivial.
You're of course referring to the current bogus CPI, which was put into effect in the 1990s to hide the real rate of inflation.
It conveniently leaves out nearly every major source of inflation a person would actually want to measure.
Let's just assume this is true. CPI, as currently measured, has been in place since ~1996. One can thus safely assume CPI would reflect the alleged inflationary effects of QE on price levels, regardless of how accurately it measures the actual rate of inflation, since it represents a measurement of some consistent snapshot of the total rate of inflation throughout the entirety of QE.
But CPI shows no change in the rate of inflation due to QE, and even more curiously, tells us inflation is currently lower now than pre-QE. Regardless of your opinion of its measurement of "real" inflation, the fact remains: there has been no uptick in price levels due to QE (startup valuations aside, hah!), despite the intuition that it ought to have resulted in substantial inflation. Hence, cause for concern.
EDIT: And I say all of this as someone who was horrified of inflation back when the Fed first started QE. So far, I appear to have been worried about the wrong thing.
It's really more of a power/control issue than anything. The _entire point_ of centralized banking is to _cause_ inflation, just not enough that it becomes an issue.
If everything is floating down with deflation, it's not too bad. For the fixed rate debtors, well they made a calculated risk that inflation will go up.