Many critiques of austrian econonomics say that deflation is bad and that gold cant be used because it creates deflation.
Is deflation even bad, I understand the concept but to me it seems ok
If it is bad how does a free society counter a “deflationary spiral”
Thanks in advance
Deflation is not bad, but it is associated with depressions, which are bad. Because of the contraction of the money supply and falling prices that happen during a depression people, as they often do, mix the symptom with the disease and target the symptom. You’ll find a mild deflationary trend in times of intense economic progress as well, but no one complained about it then. George Reisman has done some good writing on this and he usually differentiates the concepts by refering to deflation and deflation-depression seperately as required.
Here’s a good article.
The problem is not deflation. The problem is when the government does not allow wages to fall. Government backed unions and minimum wage laws are probably the biggest culprits.
Tell them the definition of inflation or deflation is not correct. Inflation is the increase in money or credit by the banking system and deflation is the decrease in money or credit by the banking system. The inflation has already happened and is currently under way.
Inflation is not the rising in price of some basket of goods nor is deflation the lowering in price of some basket of goods. These are effects of previous inflation/deflation.
As for a deflationary spiral: Prices can only drop to the level they would have absent previous inflation so there is a floor for the effects of falling prices. But, the theory of a deflationary spiral violates the law of supply and demand: That is as the price of something falls, more is demanded. So even in housing there is a point where people will buy houses at the rate they did previously. Similarly as the price of something falls, less is supplied.
As for lowering prices being good or bad: Lowering prices is GOOD for an economy, with a stable currency, technology will give suppliers the ability to make things cheaper. This process makes consumers better off. There is no better example of this than the electronics industry where advancing technology has made electronics progressively cheaper and at the same time more appealing to consumers.
Eric, the problem with a lot of Austrian thinking of deflation is simply that it isn’t consistent with other parts of their macro thought, noticably the business cycle. The fact of the matter is that in the face of a deflation prices won’t all adjust downwards immediately in the long run, Humean way a lot of Austrians imagine them to. Prices will adjust downwards at various speeds depending on a number of factors that aren’t always related to their scarcity. For example, long term contracts and cultural factors may mean that the adjustment of wages doesn’t occur and unemployment will result. There’s also the game theoretic “who goes first” problem that Yeager has noted.
I don’t even know what this means. Prices can drop quite considerably in the fact of a deflation, theoretically there is a “floor” (although, I would guess that under modern monetary arrangements it would be pretty low), I suppose, but by the time is has been reached unemployment could be very severe. The notion of a deflationary spiral doesn’t violate the laws of supply and deamd (and as far as I can tell it’s pretty much how Hutt conceived depressions). As the money supply decreases (or money demand increases) if prices aren’t allowed to fall then quantaties will. However, this will only further exacerbate the deflation as there are less goods against which money is bid.
Then what do you call it when prices rise because of a general reduction in supply of goods and services? Inflation and deflation refer to the overall price of goods and services, not the amount of currency in circulation. The amount of currency in circulation can affect the prices of goods and services, but so can supply.
Eric,
I use the term “inflation” to mean an increase in a money supply relative to demand; likewise, I use the term “deflation” to mean a decrease in a money supply relative to demand. Neither monetary expansion nor contraction are inherently inflationary nor deflationary. (I have been persuaded by Professor Steve Horwitz and others that Mises also held this position.) If I want to decribe an absolute change in the quantity of money, then I just write “an increase/decrease in a money supply,” or “monetary expansion/contraction.” I prefer to preserve the words “inflation” and “deflation” to describe a relative change in the supply and demand of money, because, in my opinion, that is the most important economic variable – especially for understanding business cycles.
Both inflation and deflation are a mismatch in the supply and demand for money, and both have a propensity to cause malinvestment. With inflation there is a tendency for bad invesments to get credit, and with deflation there is a tendency for good investments to be denied credit. The reasoning behind this claim is the same for each. Inflation creates distortions because prices do not immediately adjust to monetary expansion, temporarily giving additional purchasing power to early recipients of the new money. Meanwhile, deflation creates distortions becase prices do not immediately adjust to monetary contraction, temporarily making business activities prohibitively costly.
If the two paragraphs above seem repetitive, it’s because I am trying to stress the symmetry between inflation and deflation.
A deflationary spiral can occur in response to the distortionary effects of deflation. As good businesses fail and good investments are denied credit, a financial panic may ensue. A “flight to liquidity” then increases the demand for money even more, intensifying the deflation unless money supply can increase proportionally. In other words, a sudden increase in the demand for money and its distortionary effects (which reduce productivity), can compound themselves when the money supply is held constant, (or even reduced, which is what some say happened during the Great Depression).
Regards,
Lee Kelly
I believe you are correct, in as much that the money supply was never conceived to be static even in a free economy. It’s just that the artificial increases/decreases due to government meddling have negative effects that demand driven increases/decreases in the money supply don’t have. Again, I think Reisman has outlined these pretty well in some of his lectures/articles that I’ve heard/read.
I’ve never heard it explained differently from Austrians who to my knowledge acknowledge the various factors which affect pricing. Where is this incongruence you claim written about or demonstrated? With regards to wages specifically I don’t think Austrians argue stickiness per se but it’s power. DiLorenzo recently posted/talked about examples of some companies where nominal wages cuts were taken, and were taken for the expressed reason that the market couldn’t support the current workforce at the previous wage. In the end all the factos affecting the fall are subsumed in a price that must and will fall. It’s also a convenient argument to make while ignoring the fact that the ongoing inflation is at the very least short circuiting the price mechanism to a degree, stopping prices from falling. Murphy addresses this point rather neatly here. Put simply Austrians do not think prices will fall immediately, just that they will adjust, and would do so much faster if the government wasn’t desperately undertaking measures to stop prices from falling.
It seems a bit of a contradiction to say the market won’t let prices fall in enough time to allow for market clearing level to be reached, while the same people who are saying that at the same time and, presumably out of the other side of their mouths, are saying the government must absolutely step in to stop a precipitous price drop which will destroy the economy. I mean which is it, will they not fall in time or fall too fast and indefinitely until everything is worth nothing unless there’s a massive cash credit pump from The Fed?