Deflation Question

Economics Economics Questions
1

And this marginal reduction of consumer
spending, far from impairing aggregate production, will
rather tend to increase it. The simple fact is that all resources
that are not used for consumption are saved; that is, they are
available for investment and thus help to extend production
in those areas that previously were not profitable enough to
warrant investment.

–Ethics of Money Production

Here is my question. Lets say that fractional reserve banking is eliminated and banks tend to opperate as warehouses for money storage (though they may also offer time deposits). Yet, if deflation is expected, we know that consumers will postpone consumption thinking that prices will fall, but without fractional reserve banking where consumers would simply keep said money in storage like misers causing declines in purchasing power of the dollar leading to more expected deflation and more postponed consumption.

Where am i getting stuck here

2

Paradox of Thrift? There’s a little thing called time preference: At some point the savings are no longer worth the additional wait and it is at that point the purchase will be made.

3

I thought deflation meant an increase in purchasing power.

4

Ya people buy when they can afford it. It would be asinine to continue saving year after year after year after year simply because you want to save a few more bucks.

And to illustrate this point. Consider HDTV’s (or PC before that). Prices started out extremely high and fell rapidly, according to the above theory, sales of HDTV’s or PCs should have stayed flat for many years. In reality, sales exploded as things got cheaper.

5

Jeremiah,

Could you refine your question? Here is what I think you are asking:

Hulsmann says a marginal reduction in consumption results more resources being available for investment. In contrast, there is the Keynesian paradox of thrift (which has been debunked in the Austrian literature.)

You present a scenario of deflation without a central bank, with banks operating as money warehouses or accepting time deposits (no fractional reserve lending). Thus, the deflation you describe will not be the destructive type encountered with a credit system collapse. The type of deflation you describe is the good type that results from increased productivity, the result of capital investment. Consumers will have the pleasant effect of an increase in purchasing power over time.

Imagine saving money for 40 years, and the purchasing power remains intact or actually increases! Our only experience, due to the central bank, is that of the purchasing power of our savings being wiped out over our lifetimes, making us wards of the state, dependent on social security (I digress, but this does show the seriousness of the problem).

There is no reason to believe consumers would hoard money into oblivion under such conditions (unhampered market). Sure, some would hold off if they think they can get a better deal later, but there is nothing unusual about that, they are following their own subjective value scales and will exchange their money for goods when they subjectively value the goods more highly over the money. They is no reason to believe they will prefer to starve to death or go without goods of all kinds because they will get a better deal later.

“Gee, the purchasing power of my money is increasing, I better NOT spend it”. That just does not make sense. Now, if one says “I fear losing my job, so I better save and not spend”, then that does make sense. To call such behavior “hoarding” is ludicrous.

The hoarding is the result of the consumer reaction to a credit system collapse (central bank induced boom gone bust). Of course they will save when they fear losing their jobs, etc. Why would I buy a house now when I can buy one a year from now at a lower price? The current housing deflation is not the result of unhampered market conditions that you describe in you example. The destructive deflation we are experiencing now resulted from the previous Fed intervention.

Are you getting stuck by not recognizing the distinction between the two types of deflation?

6

Are you saying that in an unhampered market inflationary effects on the value of money as savings would be minimalized?

7

Yes, that is what I am saying. What is unclear about this?

8

The logical conclusion would be “0%” Inflation = best outcome for savings in dollars. Is that possible in an unhampered market?

9

Yes because this sort reasoning is based on assumptions that don’t make any logical sense. Namely, that people will stop consuming. People must continue to consume. If they put off on some consumption due to speculative expectation it can only be temporarily. This is why as prices drop, pressure to buy begins to build. There is a negative feedback loop here which will put on the brakes and not a positive feedback loop which will crash all prices to the floor. If the latter were true, then the proposition that wants are never satisfied would be false.

10

Have there even been any real empirical accounts or evidence of a “deflationary spiral” that economists always assume will happen?

11

@mahash

Yes, the Great Depression.

12

So which is it already? Excess demand for money causes prices to spiral downward or prices to just freeze due to some “public goods” problem?

13

If a currency is expected to increase in value, the proper response is to bid up the currency to a level of equilibrium of buyers and sellers. If the currency rises fast and far enough, people will change their expectations. Having too much wealth is not really a problem to begin with.

Most problems of deflation are the result of governments attempting to stem it. A well-believed expectation that something is at an incorrect price is economically illogical because if people believed that a currency was worth X amount, it would be worth X amount. Government meddling and information of possible intervention causes a lag in effect which prolongs the deflation expectation and corresponding lack of buying certain types of goods.

14

Thomas Dolby - Sale of the Century

Thomas Dolby… the Austrian?

15

No, that is not the logical conclusion. I can’t say what the “best outcome for savings” means. Capital formation and the resulting increased productivity would increase the exchange value of the existing commodity money (in an unhampered market). New production of commodity money (ie, gold for example) would be inflationary and would decrease the exchange value of said money.

But the unhampered market would provide a natural brake to money production. The gold mines would slow down if each ounce of newly refined gold is buying less labor and capital goods used in mining. If the inflation continued, gold would eventually be removed as a money by being transformed into other uses, ie, ornamentation. The unhampered market has a natural brake on inflation.

Not so with the central bank.

I said nothing about “0%” inflation. Inflation (money production) would be an entirely market driven process. I cannot imagine a scenario in which a commodity money (ie, a money a superior as gold) could be driven to near zero exchange value over a person’s lifetime like a fiat currency.

16

I would want the relative quantity of money in circulation to stay the same, whatever medium for exchange money happened to of been. That way, my savings would maintain a stable purchasing power over commodities and resources in the future when I wanted to actually utilize it.

17

@DD5

http://austrianeconomists.typepad.com/weblog/2009/10/hayek-on-deflation-and-the-great-depression.html

I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.

18

First you didn’t answer the question. Does deflation cause prices to spiral downward or prices to freeze?

Second, the OP is talking about deflation that results from productivity enhancements, where as the quote you provided deals with a monetary induced deflation. According to the theory that even you proclaim to adhere to; MET, there is no problem with deflation that is induced by productivity enhancements.

Third, even if there was a deflationary policy (which is debatable among Austrians) following the crash of 1929, this would only work against you and disprove your spiral theory. It would have to be that the drop in prices were not due to the contraction in the money supply or that prices just spiraled downward out of control way beyond any such contraction.

That quote by Hayek is completely irrelevant.

19

Oops, I misunderstood Mahash’s question. For some reason I thought he was asking a question along the lines whether or not there has been harmful deflation. Anyway, you can ignore my other posts in this thread since they are not relevant.

20

Before you and I get into a conversation about this, let’s see if we can get Jeremiah to chime back in. I’d like to know if any of the replies so far have addressed his question. And I’m still not quite sure I understand what his question is.