I discussed libertarianism with a friend the other day, and he insisted that deflation hurts the economy because nobody people will tend not to spend money. His example was Japan.
Is he right?
People in Japan don’t spend money?
The US went through a lot of deflation in the 19th century, yet the economy expanded at breakneck speeds. Tech products experience deflation, yet tech companies are among the most productive and profitable (think: Microsoft, Apple, Sun Microsystems, Google, Yahoo, Amazon).
Is this bs or not?
My answer will be different to that given by most other posters here, but the answer is, in my opinion, that it depends.
You need to distinguish between two different forms of deflation, the first being the result of an increase in the demand for cash or a decrease in the supply of money. The second is the result of increases in productivity. Now, I’d say that the former can be damaging to the economy, since the reduction in prices that must follow is not the result of purposive action by the entrepreneurs who must lower their prices they will be apprehensive to do so. Moreover, there is the game theoretic argument that an individual producer will not want to lower his prices until his suppliers have done so, however, since the same applies to his suppliers problems may occur. Of course, there are other causes of price stickiness such as long term contracts and cultural factors. However, the main point is that since not all prices are equally “sticky” and the “stickiness” needn’t be the result of consumer wishes, the reduction of prices that follows will usually distorts the structure of relative prices.
On the other hand, in the case of an increase in productivity it is the individual prices that must drop and they do so because it is in the interests of the entrepreneurs supplying the goods.
As concerns the question of perfect competition, the point is not so much that it is “bs” but that it probably isn’t relevant to the way the actual economy functions. More importantly, if one were to compare the free market to the construction of “perfect competition” it would inevitably fall short every time. But what matters is not the extent to which to economy replicates the theoretical construct of “perfect competition” but how well a given arrangement of institutions ranks against another one. It’s one thing to say that perfect competition will maximise consumer surplus and therefore the government must try to make markets conform to the model of perfect competition. It’s another to say that given the way things work in the real world, capitalism will trump socialism or whatever.