deflation is bad for business.

[Peter_Van_Wieren]

On another forum someone asked, in the context of a gold money system:

“deflation question: why would I buy inputs for 1lb of gold if by the time I sell the output I’ll get paid only half of it?”

The idea being that deflation causes people to prefer spending leisure time rather than production. Of course, there is the consideration of praxeology about whether people prefer leisure time to the final outputs their labor produces (goods and services). My point: deflation which arises due to enhancements in production is welcome, people can enjoy more leisure time and not suffer the loss of goods and services. I am assuming here deflation came about because of increased production, not because of population growth. I have not thought through the latter case.

I appreciate any insights offered on the “Inflation is bad for business” argument:

[z1235]

@Pete

The idea being that deflation causes people to prefer spending leisure time rather than production.

Wouldn’t the resulting decrease in production also decrease deflation to a point where production becomes attractive again? At the extreme, if we all relaxed and no one produced, there’d be no production to cause deflation.

Z.

[LibertarianfromGerma]

@**z1235**

Wouldn’t the resulting decrease in production also decrease deflation to a point where production becomes attractive again? At the extreme, if we all relaxed and no one produced, there’d be no production to cause deflation.

Exactly, the way I see it is that it should be desireable that enterprises which yield less than the average increase in productivity (which should equal the inflation rate if the money supply was to be stable iirc) are discouraged. Only if you put resources to use in a way that make them not only profitable for current conditions but for conditions for when the products are actually consumed.

An extreme example would be to imagine that if I use some wood to build a float during the stone age, but I finish in modern time (disregard labour costs, not important in that example). When I started in the stone age, the investment seemed like a good idea as floats probably were considered a good use of resources, but in the modern age transforming wood into floats (not as a hobby but as an industrial product) is not. So if I guess the correct deflation rate and the time that my enterprise takes, I will find that transforming current wood into future floats is not profitable if the value of floats at the time that I would be able to sell them is less than the value of wood at the point of time that I start my project.

[cret]

if gold and or silver were used as money can you really say that there would be deflation???

has gold and silver for coin bullion or money stopped being produced. is any so-called deflation that occurs only really happen with the current currency organization??

i am sure various extensions of credit woudl occur under a gold and silver money…but would they be more likely to be extending goods on credit rather than a credit certificate???

[billott1]

I disagree about deflation incentivizing sloth. People do not work for money, they work for the medium of exchange to purchase stuff with the money. If the money they make becomes more valuable then people will have more incentive to work as they are getting more for their labor and will be able to save more. People do not normally spend all of their earnings, they save some portion of them. The best part of deflation is that the savings of people increase in real value over time. So entrepreneurs can use these savings to make future investments in production thus expanding the wealth of society.

It is inflation that creates sloth. Inflation destroys savings. So people begin to save less and loan more in the presence of inflation. This process leads to over extension and default.

[Esuric]

“deflation question: why would I buy inputs for 1lb of gold if by the time I sell the output I’ll get paid only half of it?”

There is more to profit than just revenues; there is also the cost element. Rapid and continuous deflation is, of course, absolutely destructive, though it may sometimes act as a necessary correction (to reverse inflations and restore real relative price ratios). You always want to avoid rapid price fluctuations since it defeats the purpose of the price mechanism. But perpetual deflation, caused by productivity gains, is the ultimate economic stimulus. Prices fall, but costs typically fall faster. Production, during deflationary periods (periods of increased savings and a higher degree of capital per worker) is redirected towards producer goods, which, ceteris paribus, reduces the cost of inputs, having a multiplier effect all the way through the structure of production (there is a reduction of costs at each stage of production). Firms also employ, at the margin, a lower degree of the original means of production (land and labor), and pay a lower rate of interest (higher savings = deflation = lower rate of interest).

There are many more factors involved, but the belief that deflation is bad for the economy is pure unbridled confusion.

[DD5]

@Ensuric

Prices fall, but costs typically fall faster.

What exactly do you mean by this? I’ve seen you state this before. Prices are essentially costs.

[PirateRothbard]

“why would I buy inputs for 1lb of gold if by the time I sell the output I’ll get paid only half of it?”

In a commodity based monetary system you can never really predict deflation, anymore than you can predict gold futures now. Deflation in a commodity based monetary system implies an increase in the relative value of the commodity(usually gold) visa vis other goods.

If you could predict this you could become incredibly wealthy.

[Esuric]

What exactly do you mean by this? I’ve seen you state this before.

Costs = input prices; Prices = output prices (standard economic jargon).

[DD5]

“Costs = input prices; Prices = output prices (standard economic jargon).”

Yes, that’s what I thought you meant, but wanted you to define it.

Prices of consumers goods are imputed backwards to ultimately determine prices of factors. In other words, prices determine costs. So how do costs fall faster then prices? Or more accurately, how does is it make sense to talk about good or bad rates of fall (or rise) of one as oppose to the other? If one falls faster, it’s due to future expectations of prices as perceived by the entrepreneurs. This seems like a good thing.

[Esuric]

So how do costs fall faster then prices?

Prices and Production (Hayek), The “Paradox” of Saving (Hayek).

Or more accurately, how does is it make sense to talk about good or bad rates of fall (or rise) of one as oppose to the other?

Clearly you don’t want costs rising faster than prices, or prices falling faster than costs (in the aggregate). Such a condition entails some sort of imbalance which must be corrected (by the market).

[DD5]

As I’ve said above (edited the previous post), if costs are falling faster [or slower] relative to output prices, and it’s due to entrepreneurial expectations of future conditions, how is this a bad thing. This is exactly the process of the market making the correction. You make it sound as though this process is independent of real action by market participants when you imply that this must be corrected. What I’m trying to say is that it seems that what you are describing as a problem is actually the solution, or more accurately, the market already making the corrections.

[Esuric]

As I’ve said above (edited the previous post), if costs are falling faster [or slower] relative to output prices, and it’s due to entrepreneurial expectations of future conditions,

Well it’s due to many factors (demand for money, government intervention, regulation, endogenous rigidities, transaction costs, expectations, ect). Entrepreneurial expectations are caused/influenced by market conditions, and not by the “animal spirits.”

how is this a bad thing.

What do you mean? Depressions are “bad,” too say the least.

This is exactly the process of the market making the correction.

I didn’t say that prices will fall faster than costs in perpetuity. In fact, I said that such an imbalance has to be and will be corrected by the market.

You make it sound as though this process is independent of real action by market participants when you imply that this must be corrected.

That’s your misinterpretation. Maybe you’re putting words into my mouth?

What I’m trying to say is that it seems that what you are describing as a problem is actually the solution,

Problems typically precede solutions.

[Stephen_Forde]

@ the OP

@"[Rothbard

(http://mises.org/rothbard/mes/chap8a.asp#2._Effect_Net_Investment)"]

We have seen the impact of new saving, i.e., a shift from con­sumption to investment, on the prices of goods at various levels. What, however, is the aggregate impact of a change to a higher level of gross savings on the prices of factors? Here we reach a paradoxical situation. Net income is the total amount of money that ultimately goes to factors: land, labor, and time. In any equi­librium situation, net saving is zero by definition (since net sav­ing means a change in the level of gross saving over the previ­ous period of time), and net income equals consumption and consumption alone. If we look again at Figure 41 above, we see that the total income for original factors and interest can come only from net, rather than gross, income. Let us consider the new ERE after the change has taken place to a higher level of saving (ignoring for a moment the relevant conditions during the period of change). Gross savings = gross investment has increased from 318 to 338. But consumption has declined from 100 to 80, and it is consumption that provides the net income in the equi­librium situation. Net income is, as it were, the “fund” out of which money prices and incomes are paid to original factors. And this fund has declined.

The recipients of the net income fund are the original factors (labor and land) and interest on time. We know that the interest rate declines; this is a corollary of the increased saving and in­vestment in the productive system, caused by lowered time pref­erence. However, the absolute amount of interest income is gross investment multiplied by the rate of interest. Gross investment has increased, so that it is impossible for economic analysis to determine whether interest income has fallen, increased, or re­mained the same. Any of these alternatives is a possibility.

What happens to total original-factor income is also indeter­minate. Two forces are pulling different ways in a progressing economy (an economy with increasing gross investment). On the one hand, the total net income money fund is falling; on the other hand, if the interest decline is large enough, it is possible that the fall in interest income will outstrip the fall in total net income, so that total factor income actually increases. For this to occur is possible but empirically highly unlikely.

The one certain prospect is that total net income for factors and interest will fall. If the total original-factor income falls, then, since we have implicitly been assuming a given supply of original factors, the prices of these factors, as well as the interest rate, will “in general” also decline.

That the general trend of original-factor incomes and prices may well be downward is a startling conclusion, for it is difficult to conceive of a progressing economy as one in which factor prices, such as wage rates and ground rents, steadily decline. What in­terests us, however, is not the course of money incomes and prices of factors, but of real incomes and prices, i.e., the “goods-income” accruing to factors. If money wage rates or wage incomes fall, and the supply of consumers’ goods increases such that the prices of these goods fall even more, the result is a rise in “real” wage rates and “real incomes” to factors. That this is precisely what does happen solves the paradox that a progressing economy ex­periences falling wages and rents. There may be a fall in money terms (although not in all conceivable cases); but there will always be a rise in real terms.

The rise in real rates and incomes is due to the increase in the marginal physical productivity of factors that always results from an increase in saving and investment.[10] The increased productivity of the longer production processes leads to a greater physical supply of capital goods, and, most important, of consumers’ goods, with a consequent fall in the prices of consumers’ goods. As a result, even if the money prices of labor and land fall, those of consumers’ goods will always fall farther, so that real factor incomes will rise. That this is always true in a progressing economy can be seen from the following considerations.

[DD5]

@Stephen

Rothbard: “That this is always true in a progressing economy can be seen from the following considerations.”

Actually, the qualitative proof for the rise in real wages that comes after this is brilliant.