I’m having a debate with a few long-time online acquaintances and the subject of the gold standard came up. One of them raised a question that I’m not sure how to answer. The question is: what is the incentive to invest under a system of very low monetary inflation/decreases in the price index?
A simplified case: suppose you have $100 today stuffed in a mattress. Over a year, the total amount of goods and services in production has increased 5%, so the $100 has $105 in purchasing power today. Instead of getting a guaranteed 5% return, what is the incentive to invest and risk losing the money?
I feel as though I’m missing something here, and if someone can tell me what that is, I’d also be grateful to them for that too.
The fact that there’s deflation is irrelevant. Saying “I’m guaranteed a 5% return (from deflation), what’s my incentive to lend and risk losing my money?” is exactly the same as saying “I’m guaranteed a 0% return (price stability), what’s my incentive to lend and risk losing my money?”. Either way, losing your money is a -100% return (loss). The answer, in both cases, is that you get a risk premium for risking your money (if you didn’t then nobody would ever lend money!). The reason lending money gives you a return is that you get compensated for the risks it entails. The risk of needing liquidity, the risk of the borrower defaulting, etc.
The incentive to invest is the probable return on the investment, of course.
You tell me…would you rather have a “guaranteed” 5% return (scare quotes because you can’t guarantee an increase in the value of your money like that), or a 85 percent chance of a 265% return on an investment?
As price inflation increases time preference, so deflation would decrease it, leading people to trade immediate consumption for future value. i.e. invest
If $100 a year from now will have have the purchasing power of $105 today, then $101 a year from now will have the purchasing power of $106.05 today.
So, investing and earning a dollar is better than not investing and still having the original $100. This supposedly “anti-deflation argument” is just smoke and mirrors.
