Deflation versus inflation

Economics Political Theory
1

I’ve read many articles on the merits (or lack thereof) of the huge bailouts and the need to fight against deflation… while I generally agree that the bailouts are all misguided and are basically theft and a transfer of wealth from the winners to the losers… and that this may lead to inflation, which is also a transfer of wealth, there do seem to be some aspects of human nature that would make inflation more desirable than deflation. Irrespective of the merits of the bailouts and of fractional reserve banking, I’d like to tackle specifically the issue of deflation vs inflation and which one is more compatible with human action and will:

  1. The problem of “sticky” wages and prices. Realistically speaking, nobody likes to see their wages drop, and businesses are reluctant to lower their prices. In the circumstances of a shrinking money supply many people could find themselves out of jobs as the money supply shrinks. However, few will complain about a 3% wage increase (vs a 3% wage drop) even if in real terms they did not gain anything at all. Gaining something always feels better than losing something, even if it’s only in nominal terms.

  2. The problem of debts: In a deflationary environment, people with mortages, car loans, find it harder and harder to meet payments. They may eventually be forced into bankruptcy. In an inflationary environment these same people find it easier to make payments, therefore an inflationary environment is the one that they prefer.

  3. Falling commodity prices: Well, falling gas and oil prices are definitely good things about deflation, but seems that they are more symptoms of depression than deflation as the prices are falling relative to other goods. If we had good economic times in conjunction with deflation then you couldn’t expect to see the prices of gas fall faster than the prices of other goods. More likely it would fall more slowly as economic growth placed increasing stress on limited supplies.

I am not making the argument here that inflation or deflation are bad or good… they are both distortions and they are both transfers of wealth… instead I am making an argument that if we are to have one or the other, inflation would seem to be preferable as it is more compatible with people’s actions and desires.

2

I’m not sure you can make that argument.

3

Hey guys first post. I just posted about this on “The Big Picture” Blog. Good site btw. Well if someone is going to manipulate the money supply simply put those in debt will want expansion and those with Cash will want contraction. GM and others pray for Exapansion and cash sound companies EXBD (only one I can think of off the top of my head) will pray for contraction. I am in debt, so I guess I want expansion. I would argue that it is normatively better to have a contraction now given the amount of businesses that aren’t cutting it and are living off of debt. Once the credit freezes these debt laden companies should collapase and the economy go through a tough time only to do better in the long run. IMHO

4

I suppose “preferable” is subjective. Maybe instead of preferable I should say something else, such as “compatible”? I don’t like the idea of the inflation that may be coming, but as far as I can see the issue of sticky wages and of debts seem to be valid points in favor of inflation vs deflation.

5

Neither inflationary or deflationary policy should be pursued. However, “the need to fight deflation” that you are referring to is actually fighting against the market’s correcting response to the distortions brought about by government intervention. So it does not really apply in this case.

I don’t think sellers are having any problems slashing prices now. When I was Christmas shopping, nearly everything was 50-75% off. As far as wages go, people aren’t that stupid. Even the slow ones will eventually figure it out when the others aren’t getting pissed at their wage cuts. Are we really going to be as arrogant as the Keynesians and assume that we’re the only ones who can possibly understand basic economics? People adapt.

Simply encourages savings. A good thing. Also, deflation rates will be very low. Especially when compared to the Fed’s inflation rates.

Also, I just got done reading this quote from Murray Rothbard’s The Mystery of Banking over at Brian Shelley’s blog. I only just found this blog, but the stuff I’ve read has been pretty great. (check it out)

6

I think the concept of “sticky” wages has to do more with mentally anchoring oneself to a number and letting that number be that standard by which you evaluate relative measures. It’s a tough sell to tell someone that when they observe that they have less money in their account that they’ve become wealthier due to deflation all around them. Perhaps the experience of inflation over the past several decades has conditioned people to always believe that their dollar is not going as far. Or maybe people just heuristically believe that up is good and down is bad (I find it fairly common in financial journalism).

7

Is there a comprehensive piece on deflation? I have a hard time even understanding exactly what deflation is…let alone why it’s good/bad. Any help?

8

Look up Hulsmann’s monograph on it on the Mises.org website.

9

Reisman’s article Anatomy of Deflation is good too.

10

Check out this site:

http://globaleconomicanalysis.blogspot.com/

and type in Peter Schiff. Mish is a big Austrian and he has been up 70% during this downturn. He is a big deflationist, his arguements make sense to me.

11

Yes, I like Shedlock too.

12

Regardless of whether deflatio is “good” or “bad”, I think there is a strong argument to be made that this is going to be what the US will experience for the next few years. Japan has been pumping extratordinary amounts of stimulus and cheap money into it’s economy over the last 20 years, but that hasn’t prevented a massive collapse in asset prices.

There is no direct correlation between the money supply and the direction of asset prices. Japan, for example, has had a continuously increasing money supply for 20 years yet has experienced massive declines in asset prices at the very same time. I see no reason a similar thing can’t happen in the US.

I have put together an in-depth podcast, outlining the case for deflation, if anyone is interested.

13

This is exactly how the Fed feels about it and why they despise deflation so much. You already gave a great answer.

If you have deflation, a corporation has to reduce costs to meet the new price points. It is easy to reduce costs on many production componants because those companies are also experiencing inflation. Say you are SubWay and you need to reduce costs. A large portion is already done for you. The price of tomatos, lettuce, beef, ham, etc are also falling in a deflationary cycle.

But there remain to obstacles that are hard to overcome. 1) Longterm contracts, particularly rent. Rent costs are not going to be easy to reduce. A Free Marketer would respond that they were a poor capitalists by committing to long term contracts when faced with a possible deflationary cycle, and thus their smarter better competitors who didn’t sign longterm contracts (for rent, or aluminum, or oil, or rubber, etc etc) will gain the appropriate advantage and all is well. I agree with this free market aspect.

  1. Wages is the BIG problem. I would think praxeology would agree with this. Human beings are different from tomatos in that humans care what value is assigned to their labor. If you ask workers to take a pay cut, many will be offended, and some to the point of quitting. If you want to have a quality work force, one componant is going to be their loyalty to the company, and cutting wages does not cultivate loyalty, it creates a large number of negative externalities.

So employeers are faced with a few real world choices. Since cutting wages or hours can have negative affects, they usually end up cutting staff, or eating the wages. Cutting staff means you decrease consumer driven demand which can lead to recession if done on a mass scale. Eating the wages, means you are being inefficent and losing profits or sales due to an inability to offer an equilibrium price.

For these reasons… because the ‘science’ of supply and demand dictates reducing wages, but the real world dictates you DON’T, most economists feel that inflation is more desireable.

Furthermore, because LOW inflation say 1-2% means companies can give nominal Raises. People feel better about their job and their boss and their situation - possiblely resuliting in increased efficency and productivity -EVEN though in real dollars they received no raise at all… is a further incentive to support minimum inflation, and particularly over deflation. (ex. My boss give me a $3000 raise!!! I am going to work so hard and prove he made the right decision, and I am going to throw away that job offer from the competitor, my boss cares and I am going to recipricate)

I think the Austrians have some good arguments, but I don’t think they realisitic address productivity and ‘worker moral’ in terms of nominal wage increases – and – both nominal and real wage decreases.

If there is a consise argument that explores those human phenoms, I would like to read it.

Ixtellor

14

Hey smart Austrian theorists, I am DEEPLY interested in your rebuttals to my observations on deflation. (POST ABOVE)

Do Austrians have theories about the motivation, loyalty, and happines or workers in regards to productivity? (I think you would be against loyalty, as it defies perfect competition and might lead to States)

Ixtellor

15

Oh. The fed is a sentient organism. That’s quite…interesting ? Confused ? Wholly unscientific ?

16

Since money is getting more valuable and thus prices are going down, lower nominal wages don’t mean lower real wages.

If they get paid in stronger currency they are not taking a pay cut. Also, the problem is that people who deserve to be paid X get offended when they’re paid X ? Wow…Maybe the state should provide free psychological assistance for workers or something ?

17

For someone who previously stated that you don’t have much time for posting, and you only post to the most intelligent posters; you have little empathy of others’ time.

You cannot make such an assumption for there is no way for economics to objectively determine individual’s valuations. Plus, economics is not concerned about maximizing human happines (one can apply economics to do that, yes; but its not the goal of the science of economics), instead what it is worried about is the causaity and consequences of human action. Its a basic epistomological point.

And all of this does not matter in economics, rather this is business management.

Externaities are the biggest cope out economics has. How about actually explaining what these would be, or just leaving them out of your analysis if nothing can be known about them.

Economists must leave their subjective valuations outside of their analysis.

Essentially, this is such a bad theory, one that makes use of assumptions galore, that its not even worth refuting directly. There is nothing to support it other than pure personal induction, and even if a worker works harder after a raise, it won’t be long until he sees that as the norm an falls back to the amount of work he usually puts out. This question belongs more to the realm of psychology than it does economics; again, therrible epistomology.

18

deflation is bad if individuals are in debt,and thus inflation is needed so that individauls can pay off such debt. the more money someone is receving from an income,then the more likley that individual will have chance to pay off his debt.

19

But why must an individual pay off his debt? One can forcast equally well for inflation and deflation. If he can’t repay it it should be on his head alone. And if he can’t pay it back at all, by selling his property, he can go into indentured servitude to his creditor. However that’s slighlty off topic and don’t want to go there at present.

20

Are we talking about prices or credit/money supply? Usually, people talk about the negativity of falling prices during a deflationary bust, when money/credit supply is shrinking. Inflation/deflation as defined by changes in the money/credit supply are “bad,” especially when money and credit are one and the same, such as under a fiat currency backed by government debt used as the base of fractional reserve lending on demand deposits.

Thus, the problems you pose aren’t strictly rising vs falling prices or inflation vs. deflation. You seem to be saying people prefer “boom” to “bust”. Because both occur due to changes in the money and credit supply, I’d say, not really - they are one and the same. Inflation can only “work” until it doesn’t, and then you must have deflation. Examples are hyperinflation and over-leverage. The more extreme the government and banks inflate, the more delicate they are to collapse, which is deflationary. It is impossible to pick one and then stick to it.

In a deflationary bust, “sticky” wages work like this: people get laid off, try to find a new job at their old rate, fail, and take a new job with less pay. In other words, they’re not “sticky”. If wages were truly sticky, they would never get a new job…until inflation drove up all wage rates. While one might argue it’d be better to lower wages to avoid unemployment, some lay-offs must occur, as the deflationary bust reveals many sectors of the economy were using up too many resources not backed by consumer demand. For instance, bankers and builders must be laid off now. There is no means for them to be profitable.

This was historically debunked in the 1890’s and 1970’s. In the former, wages stayed relatively constant while prices dropped. In the 1970’s, wages and prices rose quickly. Public opinion seemed to favor the economy of the 1890’s. The 1970’s flushed away the Keynesian theories about this and gave credence to “rational expectations” theories.

Remember that all real credit comes from savings. Thus, the solution for debts is the bane of real credit. We act like we can just create credit out of thin air to fix this conundrum; however, this is in no one’s long-term interest.

People with debt may prefer inflation in their specific case, but they don’t want rising prices that result. As a whole, if society values economy, they must value neither inflation nor deflation. If everyone is a debtor, where the heck is the credit coming from? The logical conclusion is that if this were true, the people would prefer hyper-inflation, yet history tells us this is not the case.

As far as institutions who are rendered insolvent in a delationary bust, this is often good. The quicker bankruptcies are allowed to happen, the quicker assets will be dumped onto the marketplace, allowing the market to wipe out the bad debt while placing good debt in the hands of solvent institutions. This allows the credit markets to restore healthy functioning, rather than everyone becoming day-trading speculators trying to pre-empt government decisions about “zombie banks”. Brand names may fail, but desired products will not.

Again, you say people prefer boom to bust; but if they realized they’re the same thing, they would not. Under a static money supply, falling prices would be obviously welcomed.

And part of the oil price decline was the giant bubble that more than doubled its price. Again, booms vs. busts. Consumers vs speculators.