Did I get this right? About deflation

[JohnG]

Hi

I was thinking about deflation earlier today, and I wonder if I got this right:

Let’s assume someone is selling TV’s that costs 1000 dollars each. The economy goes down, and people are less interested in his TV’s than they were before. The market value drops from 1000 to 900 (he’s still making a profit though). Now, the government decides to help this poor TV seller and begin to increase the money supply. So, the money is inflated, and the price for the TV’s rise to 1000 again. But, these 1000 dollars are now only worth what 900 dollars was worth before the government came to “help” the TV seller. So, in one way, deflation has already occured: He used to get 900 dollars worth 900 dollars, and now he gets 1000 dollars worth 900 dollars. No real difference, except that the inflation caused by the government hurt the savers.

Not only this, but I think he, the TV seller, is hurt even more in the long run: The reason why the prices got back to 1000 was because people borrowed more, but loans have to be payed back sooner or later. Therefore, people will have less money in the long run, and they will be able to buy even fewer TV’s than they could when prices were at 900 (900 real dollars, before the inflation began). Now, the market value might drop to 850, and it’s possible it’s no longer profitable to sell TV’s at that price. Sure the interest rate is low, but loans still have to be repayed.

And, doesn’t deflation pretty much solve itself (not that it has to be a problem, but anyway)? Assuming people will consume less (and I’m not sure about that, people aren’t extremely rational), they will save more, making it easier to get a loan at a low interest rate. And, they will invest. When you buy shares from a company, the company will get money too.

I’m not the first one to think about this, I just wonder if I got it right, or if I forgot something.

/John

[david_z]

it seems to me that you’re using the words “deflation” and “inflation” interchangeably.

Inflation: an increase in the money supply.

Deflation: a diminution of the money supply.

These terms are not to be confused with their effects. (e.g., Inflation often causes prices to rise, but inflation is not rising prices).

[JohnG]

Yes, I know that. Still, if the prices go down, and the government inflates the currency, that won’t create any real wealth, will it? And prices will in the long run have to go down again (… most likely through a crash) when loans are to be repayed etc. Maybe I wasn’t clear enough, sorry about it.

/John

[billott1]

You do not have correct, Austrian, definitions of inflation and deflation. You must have looked at Wikipedia or some other source. Simply, inflation is an increase in the supply of money or credit and deflation is a decrease in the supply of money or credit. Increasing or decreasing prices are effects of inflation or deflation.

If you use the Austrian definition of inflation then you will see that in the real world where suppliers require time to produce things and buyers need things to purchase that inflation/increasing the amount of money and credit is a terrible thing that leads to future poverty.

[JohnG]

I do know about the austrian definitions, and maybe I didn’t express myself in a correct way in my post, but still isn’t it correct, that government printing money doesn’t lead to higher REAL prices, but only to higher nominal prices, and that those prices (caused by excessive money production) are doomed to fall back sometime, when the bust ends, and probably be even lower then (or, hurt even more).

/John

[scineram]

@billott1

Simply, inflation is an increase in the supply of money or credit and deflation is a decrease in the supply of money or credit.

Aren’t they an increase or decrease in excess of a change in the demand for money? Horwitz and Boettke use that instead, I think.

[david_z]

@JohnG

till, if the prices go down, and the government inflates the currency, that won’t create any real wealth, will it?

You’re correct, no new wealth is created through inflation, but often (always?) due to the distortions in the price signal, the malinvestment caused by inflation actually destroys wealth, so in the end, we’re made worse off by the inflation than we would’ve been.

[JohnG]

Yep, that’s what I meant. The government can currently raise the price, but in the long run, we’re all poorer and can buy even less, causing prices to drop even more (… before the government starts it all over again).

/John

[shawn77]

When the Governement attempts to keep the prices of something artificially high by inflating the currency, it has the effect of raising all prices. Although your home may still be worth 1 million it now costs 10 thousand dollars to fill your refrigerator with groceries

[krazy_kaju]

You have to remember that central banks don’t increase the money supply to cause price inflation. The deflation right now is a sign of falling demand. The Fed wants to prop up demand by making loans more available. Of course, the Fed needs to print a lot more money to make loans more available, creating a lot of price inflation. Their goal isn’t to increase prices as much as it is to increase demand.

[slider123456]

It seems to me that in the early part of this century that manufacturing companies were pushing for the system we have in place now to counter constant deflation that occurred due to new efficiencies and competition. Most industries where similar to the electronics industry today where prices would continually drop. This had the effect where holding onto money would equate to more purchasing power over time. Manufacturers saw this as a drawback since there was no real incentive to spend and it equated to an ever rising wage for workers. Implementing a system where inflation is the status-quo gives much more power to manufacturers and puts the pressure of always trying to get a raise to keep up with inflation onto the workers and takes the pressure of having to sell quickly off of the manufacturers.

On a gold standard and some other monetary systems without rapidly increasing money supplies prices would steadily go down due to new efficiencies and competition barring any monopolies or cartels controlling prices. The rising prices under frb has the effect of making investing and spending a necessity so that spending power is not lost to inflation.

[david_z]

@slider123456

It seems to me that in the early part of this century that manufacturing companies were pushing for the system we have in place now to counter constant deflation that occurred due to new efficiencies and competition.

Do you have any evidence for this?

@slider123456

Most industries where similar to the electronics industry today where prices would continually drop. This had the effect where holding onto money would equate to more purchasing power over time. Manufacturers saw this as a drawback since there was no real incentive to spend and it equated to an ever rising wage for workers.

Wrong. Although the incentive to spend money on current consumption may be less, the incentive to invest money in order to have more money (in nominal and in real terms) in the future, is greater. The latter is what businessmen/entrepreneurs do: they invest money now, allocating resources towards the satisfaction of future demands/needs/wants, in hopes of earning a profit. As they earn a profit in nominal terms, the real fall in the general price level has made their purchasing power even greater than it otherwise would’ve been.

@slider123456

Implementing a system where inflation is the status-quo gives much more power to manufacturers

Not necessarily, a significant part of the nation’s economy pre-1914 was agrarian. Sure, there was industry, but not like we know it today. The system that we have to day is implemented to give much more power to bankers.

@slider123456

The rising prices under frb has the effect of making investing and spending a necessity so that spending power is not lost to inflation.

Wrong. In the absence of FRB/banking cartel, spending power is never lost to inflation.

[slider123456]

@slider123456

It seems to me that in the early part of this century that manufacturing companies were pushing for the system we have in place now to counter constant deflation that occurred due to new efficiencies and competition.

@david_z

Do you have any evidence for this?

I have no evidence other than reading between the lines. Manufacturers is a poor description a better description would be a collusion between financial and some corporate interests who believed an inflationary system would be more beneficial to them .

@slider123456

Most industries where similar to the electronics industry today where prices would continually drop. This had the effect where holding onto money would equate to more purchasing power over time. Manufacturers saw this as a drawback since there was no real incentive to spend and it equated to an ever rising wage for workers.

@david_z

Wrong. Although the incentive to spend money on current consumption may be less, the incentive to invest money in order to have more money (in nominal and in real terms) in the future, is greater. The latter is what businessmen/entrepreneurs do: they invest money now, allocating resources towards the satisfaction of future demands/needs/wants, in hopes of earning a profit. As they earn a profit in nominal terms, the real fall in the general price level has made their purchasing power even greater than it otherwise would’ve been.

I am only saying that with deflation there would be more incentive for some people to not take the risk of losing money in an investment and put it in a mattress where by sitting there with virtually no risk it will gain more spending power. I do not know how you can say it is wrong that holding money would be more common in a deflationary system than an inflationary one. In an inflationary system you have to invest or the spending power of money is slowly eroded in a deflationary system you can hold money risk free and gain spending power this would surely cause more people to hold money instead of risking it in an investment.

@slider123456

Implementing a system where inflation is the status-quo gives much more power to manufacturers

@david_z

Not necessarily, a significant part of the nation’s economy pre-1914 was agrarian. Sure, there was industry, but not like we know it today. The system that we have to day is implemented to give much more power to bankers.

Today it is also useful to big corporations since it puts the impetus of getting raises onto workers to keep up with inflation whereas a deflationary system would equal a raise every year as workers gained spending power due to efficiencies and competition.

@slider123456

The rising prices under frb has the effect of making investing and spending a necessity so that spending power is not lost to inflation.

@david_z

Wrong. In the absence of FRB/banking cartel, spending power is never lost to inflation.

I think you misunderstood what I wrote since your reply agrees with what I wrote yet says it is wrong. I am saying that under a FRB/banking cartel investing and spending is a necessity to counteract the effects of inflation where just holding money will eventually make it worth only a fraction of what it was originally worth. I also agree that monetary systems other than FRB could create money that holds its value or increases in value.

[david_z]

@slider123456

I am only saying that with deflation there would be more incentive for some people to not take the risk of losing money in an investment and put it in a mattress where by sitting there with virtually no risk it will gain more spending power. I do not know how you can say it is wrong that holding money would be more common in a deflationary system than an inflationary one. In an inflationary system you have to invest or the spending power of money is slowly eroded in a deflationary system you can hold money risk free and gain spending power this would surely cause more people to hold money instead of risking it in an investment.

In this sort of economy, holding money is not “risk free” as you put it. There is a very real opportunity cost. Furthermore, if some group of people prefer to hold cash, instead of lending, then the price (in terms of interest) that the others can command, will be that much greater, assuming the Demand for loanable funds hasn’t changed (and there is no reason to assume that it has).

You suggest that when purchasing power is increasing (because prices are trending mildly downwards) that people will be generally less inclined to bear risk for a nominal return. I say this is not the case, because in that sort of economy, a nominal return (i.e., $1 becomes $1.10 when repaid) compounds the real return (i.e., the purchasing power of $1.10 is now $1.21)

It seems that due to this effect, there would also be more incentive for some people to take the risk, since their return would be that much greater, having been augmented by a real rise in purchasing power/productivity.

[NB, I may have misread the last point you made. Oops.]