What’s wrong with deflation, in either the monetary and price sense?
If we have monetary deflation, doesn’t that mean that the purchasing power of our money is going up? We can produce and/or buy more stuff for cheap.
If we have price deflation, doesn’t that mean that prices are going down? If there is a general drop in the price level, isn’t that a good thing? We can also produce and/or buy more stuff for cheap.
Monetary:
If someone destroys money, then this results in suboptimal utilization of resources because the deflationary effect does not instantaneously propagate through the entire economy. In the meantime, therefore, while the money-destroyer is cutting back on consumption, nobody else knows that they can increase their investment accordingly. It would have been better if the money-destroyer had instead lent out the money to people who could immediately use it to fund investments.
It’s like the Austrian boom-bust cycle, only in reverse.
Price:
There’s not much you can say here, unless you know the cause of the price deflation (whether it’s monetary deflation, or increased output).
Price sense? Not a thing, generally speaking.
It should be welcomed - and is in areas such as electronics - but in the overall economy today it is considered the most taboo of taboo economic occurences because there is no way to “inflate away the debt” if there is deflation. Makes people/governments with high debt pay more in real terms yearly.
Whether or not society will change? I highly doubt it. Too deeply brainwashed and too deeply indebted for too many years.
A problem is that in a debt-driven economy like we have at the moment deflation means the absolute value of debt would be actually going up, causing repayments to be more problematic. This is particular true for government debts which, being so large, are heavily affected even by very modest inflationary/deflationary pushes. That’s why inflation is always seen as preferable to deflation by State apologists and seen with a favorable eye even by very large corporations (which always have large debts even when they are posting record results): inflation erodes the overall value of the debt owed to a creditor. When immense sums are concerned even very modest inflation will help “servicing” it by making it less problematic.
Of course in a capital-driven economy the opposite applies: under a deflationary push you get more for your money. Deflation in this case acts like a capital multiplier.
Zavoi: “If someone destroys money, then this results in suboptimal utilization of resources because the deflationary effect does not instantaneously propagate through the entire economy.”
Perhaps this may be true for fiat, but what of commodity money? If commodity money is “destroyed”, and used for production/consumption, isn’t that an optimal utilization of that good? Let’s say I needed to make semiconductors, semicondicutors require gold, so I take the gold used as money and melt it away turning it into a semiconductor. I would argue that this would be “optimal” because the market is deciding its use at the same time deflating the money supply.
Kakugo: “A problem is that in a debt-driven economy like we have at the moment deflation means the absolute value of debt would be actually going up, causing repayments to be more problematic.”
Are you referring to the monetary deflation?
True, some useful goods (e.g. semiconductors) come out of it, but the effect would still happen all the same. The market value of the gold is composed of its monetary value and its industrial value. The semiconductors fetch a price comparable to the industrial value of the gold*, but the manufacturer must underconsume by an amount commensurate to both the industrial and the monetary value of the gold in order to acquire it in the first place. The discrepancy represents freed-up resources, which won’t find their way into the hands of entrepreneurs until the price deflation has time to propagate.
*(To the extent to which the gold is used in them.)
The problem with monetary deflation is the opposite of that of monetary inflation. While the latter lengthens and widens the structure of production, the former shortens and narrows the structure of production. The main difference is that deflation does not result in malinvestment. But, it could cause some higher-order investments to no longer be deemed feasible due to the high cost of the capital-goods in question (higher rate of interest).
Price deflation is the antidote to monetary deflation. It’s the reason why there is no such thing as a permanent deflationary spiral. Also, price deflation due to higher productivity is healthy.
zavoi: " The discrepancy represents freed-up resources, which won’t find their way into the hands of entrepreneurs until the price deflation has time to propagate."
But then, is this really a “suboptimal utilization of resources” if it is done with commodity money? The market is deciding how the money/commodity is to be used.
I can see, through fiat money, that monetary deflation can be a suboptimal, because just like money is created of thin air, money is being destroyed out of thin air.
As a side note, have we ever experienced monetary deflation while on the gold standard? while on fiat?
“It’s the reason why there is no such thing as a permanent deflationary spiral.”
Keynesian like to assert that we are approaching a deflation period. But the thing that boggles my mind, is that when we are in an inflationary period, Keynesian imply the definition is price inflation. But when we are in a deflationary period, their logic implies monetary inflation. Am I crazy or correct on this point?
I’m not sure there has ever been a free-market gold standard. Regarding pre-Fed business cycles, there were periods of deflation, but most of this had to do with contracting fiduciary media, not physical decreases in the supply of commodity money. Maybe the export of gold represents monetary deflation.
On fiat, yes we have. Most business cycles, if not all (not something I really want to look up), has had monetary deflation. A higher rate of defaults, deccelerating loan creation, an increase in the demand for money, and the “liquidity trap” (or increased uncertainty) can cause monetary deflation. The price deflation we experienced after this last recession was definately not due to higher productivity.
When talking about deflation, I think Keynesians still refer to price deflation, even if they consider monetary deflation the cause of it. The same is true of price deflation, although they believe price inflation can be caused by other things as well.
deflation rewards savers over borrowers, or rather unexpected deflation does.
Deflation can also lead to unemployment if something like the government steps in an tries to prop up wages.
I think without the government and violent unions wages would be a lot less ‘sticky’ and there would really be no reason to fear deflation, (not that there really is one now)
JMFC - is it possible to have a reverse business cycle? If the government tried to set interest rates artificially high, wouldn’t that just lend to the actual market rate playing out in the market? Unless it did something like put people in jail for lending too much money or at too low a rate, which would be a bit crazy, even for the government.
JMFC - is it possible to have a reverse business cycle? If the government tried to set interest rates artificially high, wouldn’t that just lend to the actual market rate playing out in the market? Unless it did something like put people in jail for lending too much money or at too low a rate, which would be a bit crazy, even for the government.
I think it would make individuals prefer consumption to investment, or flatten the structure of production. This is effectively what is taking place in Venezuela, although it’s not because interest rates are too high, but because the government has taken other approaches to disincentivizing industrial production.
How can you tell the difference between deflation and an adjustment of price due to supply and demand?
Perhaps you all have seen/read Hulsmann’s essay, Deflation and Liberty. He proposes:
“Deflation is not inherently bad, and that it is therefore far from being obvious that a wise monetary policy should seek to prevent it, or dampen its effects, at any price. Deflation creates a great number of losers, and many of these losers are perfectly innocent people who have just not been wise enough to anticipate the event. But deflation also creates many winners, and it also punishes many “political entrepreneurs” who had thrived on their intimate connections to those who control the production of fiat money.”
well I wouldn’t disagree that a government could manipulate the structure of production to be too short sighted (I am guessing the ‘bust’ of this phase results in a shortage of goods available? too many retail stores all grabbing for fewer and fewer products coming out of manufacturers?
But what I was saying was that is it possible purely through monetary policy. It would seem like in that sort of arena, rogue ‘Austrian’ banks could thrive because they would be offering both sound money and lower interest rates to borrowers, and that the only way to stop something like that from happening would be to use the other powers of government.
The resources that are being underutilitized are not the gold itself, but other goods scattered throughout the economy.
For example, let’s say I make 40 goldspecks and consume 4 bushels of corn in a typical month. Each bushel costs 10 goldspecks (so I spend all my income on corn). One month I decide to save 10 goldspecks, so I use 30 goldspecks to buy 3 bushels of corn and lend the remaining 10 goldspecks to a farmer, who uses it to buy a bushel of corn for the next season’s seed.
So far so good: Through the medium of money, the corn that I don’t consume finds its way into the hands of someone who uses it to invest for the future.
Now suppose another month I decide to make some semiconductors that contain a total of 20 goldspecks within them. I sell them to you for 30 goldspecks (and you consequently consume 3 fewer bushels of corn than you usually do; while I myself make a profit of 10 goldspecks and consume 1 more bushel). You and I together have now consumed 2 bushels less than we normally do, while our demand for everything else has stayed the same. So what happens to this corn?
What happens is that our reduced demand for corn translates to a slightly lower market price, which causes the extra 2 bushels to be distributed to those willing to buy it. But this only can happen after the price has had a chance to adjust; in the meantime there is a glut of corn, which there wouldn’t have been if I had lent the money.
A single market will adjust pretty fast, but in reality the goods used for investment are not interchangeable with the goods used for consumption, so an even more convoluted process of price-adjustment must take place (e.g., a fall in the price of corn causes wheat prices to fall, which causes the price of farmland to fall, which lowers the price of building a factory on that land, which lowers the price of tools…).