deflation

what analyst project to happen? hyper inflation or deflation? Can anyone tell me in layman terms: why deflation is bad?

I’d like to read a detailed analysis of that question my self. But here’s my take: I would say: 'cos our whole economic system is based on inflation. You expect prices to go up for a certain amount, ask for more at your job because of that (since they sell at a higher price), you then have more money and consume more. Hurray capitalism! When you have deflation there’s no point in holding your money. Your accounts are non interest-baring so you might as well spend your money. This in turn brings back inflation, but the deflationary period might take a while to get by and that’s a period when your capital is worse less and less.

Deflation leads to cuts in production, loss of jobs, etc., why would we want that?

If deflation happens because we are producing so much stuff that our dollars simply buy more of it next year than this, then deflation is not so bad. This is deflation that results from productivity that grows faster than the money supply, and the result is 1) relatively benign, and 2) relatively easy to alleviate by growing the money supply in line with economic growth. Deflation can also happen because of a sudden destruction of large quantities of money in something like a stock crash and/or when there is a sudden slowing of money velocity because of 1) a liquidity crisis, or 2) a recession where people are compulsively saving for rainy days. This kind of deflation is very dangerous because it removes the incentive to invest at a time when companies desperately need investment. If your money will buy more next year than it does this year, then it is safer just to keep money in a bank (or a mattress) than to risk it by investing in businesses. However, businesses can no longer get the capital they need to start business up again, which then leads to greater business failure and longer recession and more hoarding of money for rainier days. This cycle is much harder to break than inflation, which can usually be handled by jacking up the interest rate.

Nice answer, bchadwick. For historical reasons and because of the hard money people on AF, we should point out that deflation that is the result of production increasing faster than the money supply is only benign if you can increase the money supply. The farmer in 1900 borrowing funds to grow a crop and then being required to pay back the money in deflated dollars due to industrialization and hard money didn’t think there was anything benign about deflation.

Deflation runs contrary to the whole idea of investment: when you invest, you would expect a positive return.

Exactly…so people dont invest. Thus causing more deflation as expectations are prices will drop. I am quite concerned that with all this deleveraging we are seeing many of the events that cause deflation, all in one (large destruction of money, lower demand, lower velocity, lower money supply to consumer as it doesnt get through the banks). I also dont think the govt could have any hope to get us out of it…

Well, there are always helicopters, but there’s a price to pay.

bchadwick Wrote: ------------------------------------------------------- > Well, there are always helicopters, but there’s a > price to pay. Helicopters don’t matter. Just ask Japan. This is just a figment of Bernanke’s idiotic “how I will reflate” theory.

http://en.wikipedia.org/wiki/Feedback The bad thing about deflation is its self-creation of a negative feedback loop that cannot be turned around without somehow creating positive feedback, but as the negative feedback has already snowballed so large, you need everyone to collectively get a hairdryer to melt the big boy.

> For historical reasons and because of the hard > money people on AF, we should point out that > deflation that is the result of production > increasing faster than the money supply is only > benign if you can increase the money supply. The > farmer in 1900 borrowing funds to grow a crop and > then being required to pay back the money in > deflated dollars due to industrialization and hard > money didn’t think there was anything benign about > deflation. The farmer is paying more than he borrowed in real terms ,due to falling prices arising out of increases in productivity.But he also benefits from the increased purchasing power of his new earnings.I dont see how it hurts the farmer when you consider his situation in toto. The lender does benefit -which basically implies that savers are rewarded. -a good benefit of increases in productivity to investors. >The bad thing about deflation is its self-creation of a negative feedback loop I dont see any negative feedback loop from falling prices. Do you see computer makers cutting investment because prices of PCs keep falling? I agree,however, about the bad effects of deflation caused by decrease in money supply. A supply side neutral monetary standard will have a decreasing real cost of goods over time as long as the time preferences of the economy as a whole allow for increases in the capital stock and advancements in technical knowledge(productivity). An increasing purchasing power of money is self reinforcing, encouraging saving and thrift, the foundation of capital formation and investment.

“I dont see any negative feedback loop from falling prices. Do you see computer makers cutting investment because prices of PCs keep falling?” To use that as an example compeletely discredits everything you have to say. Its built into their pricing models that they must continue to reduce the cost of old technology so that they can price new technology within prices that are reasonable based on consumer’s perception of added benefit. Pricing of houses, stocks, bonds, cash hold a little more weight in most people’s total asset portfolios than the computers they own, which are depreciating assets already. The fact is that there is no reason to buy a house today when its perceived that it will be half price next year. That goes for all assets affected most by deflation, including stocks, bonds, cash. An increasing purchasing power of money is self reinforcing but so is declining wages and expectations of future employment. It is not PPofMoney that gets people saving, its your future expected situation of employment and income which have a much closer correlation to your quality of life than your savings. Capital formation is based on the strength of your job market and perceptions of job security. A final point is that there will be little advancement in technology and capital stock should people be unmotivated to pursue further education if they believe it will bring them no gains in the job market.

“The fact is that there is no reason to buy a house today when its perceived that it will be half price next year.” Are houses falling because of productivity increases or due to monetary deflation? It would be great if you can predict that increased productivity will reduce house prices in the future. Any increased in nominal prices of assets because of increase in money supply is bogus.Otherwise zimbabweans would be ultra wealthy. Wealth is measured in increase in real purchasing power and not nominal pp You neeed to define deflation first. I define deflation in terms of monetary supply decrease.Looks like you use the CPI yardstick. Increase in productivity DOES NOT cause decrease in wages like you would like to believe. Deflation in money supply can ofcourse cause decrease in wages/unemployment etc.Price decreases due to increase in productivity doesnt.Uusally more productive workers are paid more.wages should increase.

Deflation also means that your mortgage in real terms is actually growing while deflation is also associated with rising unemployment. This creates a squeeze on consumers as well as a negative spiral. How do you combat deflation? Monetary policy appears to be inefective at fighting deflation, how has fiscal stimulus worked in the past?

stimulus of the world war variety work the best.everyone starts from scratch. fiscal stimulus would work to some exent if the govt already was a prudent one and ran fiscal surpluses. a fiscal deficit laden govt borrowing more money is no different from borrowing from credit card to pay off another credit card.you can run,but you cant hide

I don’t have major research to support my opinion but I think fiscal stimulus might be better than monetary because it can be specifically targeted to consumers who have no purchasing power. If the consumer has no purchasing power, they don’t buy, which means businesses don’t expand. If you just lower interest rates, businesses won’t expand because there are no consumers to buy their products, and you might get into a carry trade situation with the dollar, where you give dollars away, which devalues the currency, but the benefits go to investments outside the US. So, fiscal policy can actually target specific parts of the economy that need to be jump-started. In a normal economy, this is a very bad thing to do, because there is lots of mis-allocation. But in this case, the patient is almost already dead, so the benefits are probably better than the costs of doing nothing.

Dsylexic Wrote: ------------------------------------------------------- > “The fact is that there is no reason to buy a > house today when its perceived that it will be > half price next year.” > > Are houses falling because of productivity > increases or due to monetary deflation? > It would be great if you can predict that > increased productivity will reduce house prices in > the future. > Any increased in nominal prices of assets because > of increase in money supply is bogus.Otherwise > zimbabweans would be ultra wealthy. Wealth is > measured in increase in real purchasing power and > not nominal pp > > You neeed to define deflation first. I define > deflation in terms of monetary supply > decrease.Looks like you use the CPI yardstick. > Increase in productivity DOES NOT cause decrease > in wages like you would like to believe. > Deflation in money supply can ofcourse cause > decrease in wages/unemployment etc.Price decreases > due to increase in productivity doesnt.Uusally > more productive workers are paid more.wages should > increase. You just made my point effective. You said that deflation causes a decrease in wages/unemployment but it is the expectation of lower and lower wages and more and more unemployment that leads to a deflationary environment. Secondly, of course productivity doesn’t decrease wages, wages go down because people aren’t productive and rise again when they are, causing more productivity to be dispersed among more people (as more people don’t mean more overall productivity: law of diminishing returns) as wages draw in new job candidates and create a more competitive job market, I don’t understand why you’d mention something so obvious. Finally, deflation must almost come to a complete halt before wage increases can occur. Wages only increase when there is incentive to pay people more, meaning higher production because of higher expectations in wages and employment and higher discretionary income.

nice article by adam posen on japan and deflation http://www.petersoninstitute.org/publications/opeds/oped.cfm?ResearchID=790

All the government has to do is print a bunch of money and buy assets themselves (oil, buildings, infrastructure); problem is solved.

bchadwick Wrote: ------------------------------------------------------- > I don’t have major research to support my opinion > but I think fiscal stimulus might be better than > monetary because it can be specifically targeted > to consumers who have no purchasing power. If the > consumer has no purchasing power, they don’t buy, > which means businesses don’t expand. > > If you just lower interest rates, businesses won’t > expand because there are no consumers to buy their > products, and you might get into a carry trade > situation with the dollar, where you give dollars > away, which devalues the currency, but the > benefits go to investments outside the US. > > So, fiscal policy can actually target specific > parts of the economy that need to be > jump-started. > > In a normal economy, this is a very bad thing to > do, because there is lots of mis-allocation. But > in this case, the patient is almost already dead, > so the benefits are probably better than the costs > of doing nothing. In an environment in which the Senate can’t pass the bailout bill without adding something about wooden arrows, fiscal stimulus just doesn’t work. It turns into pork of the very worst kind and the stimulus will not be done with stimulation in mind but about bringing in favor from local constituents. There’s also the problem of starting a fiscal stimulus program with >$10T of debt (I lost count at $10T) already.