Thursday, November 20, 2008

Should we worry about deflation?

Should we be worried about deflation?  Answer: no.  Deflation (conventionally defined) just means gently falling prices. What's wrong with that? Falling prices are a boon for consumers, eventually, but more importantly falling prices are a boon for producers now who get to take advantage of lower costs to regenerate their businesses again -- in short, falling prices are necessary for the market to correct, as it is.

Deflation, in fact, is a "great liberating force," writes Jörg Guido Hülsmann, "because it destroys the economic basis of the social engineers, spin doctors, and brain washers." It rewards Mr and Mrs Saver, who've delayed spending now with the expectation of spending later, and punishes Mr and Mrs Profligate, whose spending has been part of the reason we're now all suffering.

The reason that unsound economists rail against deflation?  Because they think Mr and Mrs Profligate drive the economy.  But they don't, as I'll show you tomorrow.

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7 Comments:

Anonymous Anonymous said...

Piffle.

As an entrepreneur, let me tell you that there are two problems with deflation.

One is that deflation means that a low real interest rate translates to a zero or negative nominal interest rate. That's very bad for those trying to attract investment into new enterprises. If you're just as well off shoving your money under your mattress as investing it, then investment will fall.

The other is that for psychological reasons many prices stick at zero (particularly the price of labour). With 4% inflation I can offer my workers a 4% annual pay rise and they're happy. With 2% deflation if I tell my workers they must take a 2% pay cut they'll mutiny. Their contract has a set rate, and they're not about to take less. Don't tell me that's irrational, since it's real (not nominal) wages that matter: I know it's irrational. But it's a very real effect. Inflation of around 3% (+/- 1%) is good because it lets wages rebalance across industries (ie lets real wages decline in those industries where they should).

Of course, you'll now claim that the entire field of industrial relations should be completely different than it is. Maybe it should be: but it isn't. So until your libertarian revolution occurs, deflation is bad.

11/20/2008 05:29:00 pm  
Blogger Elijah Lineberry said...

Peter, I draw your attention to your policy of deleting 'anonymous' posts because what is written above is utter rubbish!

The idea that constant and inevitable price/wage increases is 'part of the furniture' is utter nonsense!

During the Victorian era, when vast fortunes were made and people like me were mill owners or busy establishing colonial outposts and working class people were deferential towards their betters, prices FELL...the cost of a loaf of bread at the time of the Battle of Waterloo was the same as the 'Seige of Mafeking' 86 years later.

Deflation is a splendid thing and 'bring it on' I say.

This view that interest rates will fall to zero is portrayed as some kind of evil; but not so.

Investors tend to be wimpy sorts of people with no balls who are too scared to get stuck in and invest directly themselves...and their returns become low or zero.. (amounting to a generous gift to the borrower)...so WHAT? (if you have no balls to do it yourself, don't you deserve a good rogering?)

We have deflation and prices return to where they were in 1995...well..ummmm...so 'jolly' what?!?!

We have deflation and prices return to where they were in 1983 ...ummmm....so what?

To put it another way...if prices fell back to the levels of, say, 1900, why is that a bad thing? why is that beyond the pale? what does it matter?
There is a viewpoint...from me, for instance, that in 1900 the Empire was nearing its peak, all was well with the World, and surely trying to imitate it is a good thing!

11/20/2008 07:04:00 pm  
Blogger Crampton said...

Lots of economists will worry about deflation because wages seem to be downwards-sticky: without a nominal wage cut, deflation increases real wages above what employers would want them to be. I'd expect that a sustained deflation would break this: the US had a nice period of deflation that coincided with decent economic growth late 19th century, but it would take a while for expectations to be revised and for folks to be happy with zero nominal wage increases and occasional nominal wage cuts

11/21/2008 05:20:00 am  
Anonymous LGM said...

As an entrepreneur!

Yeah.

Right.

Sure you are.

Wages can and do go down when necessary. If you ran your own business you'd sure know about that.

I had a business employing 12 people way back in the aftermath of the 1987 crash. Everyone got told pay cuts or no job. Simple as that. The business could not afford to pay the larger salaries. So the decision had to be made. One person left. The rest stayed. Efficiencies were found and productivity was improved. Remarkable how individuals can seek their own betterment and benefit rationally when the chips are down. There is nothing wrong with that.

In the next short while there are going to be a lot of talented people made redundant as businesses tighten their spending, seek efficiencies, downsize or, in some cases, fail. This is going to be an excellent time to locate skilled and motivated people who will be keen to find good work. The remuneration expected by many will be more modest than previously. Wages and salaries are going to fall in many instances. There is nothing wrong with that. That's how people adapt to the times (when they are allowed to adapt).

As for investment. Not harder to seek funding at all. For a good business seeking an ideal investor the challenge is no greater than it was at the height of the bubble. The business still needs to undertake due diligence on the funding target, just as it should have done before. The business plan will be different than previously . The quanta will likely be different and the terms and condition of the agreement for the funding will be different. But the task is no harder than it was. There are still plenty of funds looking for a place to be invested. People adapting to the situation, that's been my experience over the last two months.


Anonymous, you are not really an entrepreneur. You just made that up. Fess up.

LGM

11/21/2008 07:16:00 am  
Blogger Berend de Boer said...

People, the only reason why governments don't want deflation is that their debts will become unserviceable = crash of the system.

Inflation is great if you have debts.

11/21/2008 09:57:00 am  
Anonymous Anonymous said...

You have to distinguish between falling prices and falling money supply - deflation, properly understood, is the latter, and a deflationary policy would be harmful (just as an inflationary one is), but falling prices, of course, is a good thing.
It's possible to have inflation while prices are falling (due to increasing productivity) or deflation while prices are rising (the reverse)

11/21/2008 08:11:00 pm  
Blogger Callum said...

(Original) Anon:

If we're talking about deflation to mean the general decrease in prices, you have to remember the fact that not only consumer goods go down in price! Capital does so as well, meaning that businesses can cover the extra labour costs -if that is what you prefer to do- with increases in productivity thanks to the introduction of more capital into the business.

With interest rates: if they are on what effectively amounts to 0%, than investors will move out and production of goods will slow down, meaning prices stabilize. Then there is also the fact that your dollars will go further with prices going down than going up, which provides incentives to save rather than spend immediately.

Elijah answered the question about interest rates perfectly: they'd be low enough as to encourage continued investment, but high enough as to make sure that the money isn't given to the borrower as a gift.

If we take deflation to mean the deliberate dissolution of the money supply by the government, that is a bad thing as it leads to eventual undervaluation of goods, as inflation leads to eventually overvaluation of goods (like we're seeing now). However, if it is merely the lowering of prices over a period of time without government interference, that is a good thing -as it means that the productive forces of the world are at work, and through their ingenuity, people can enjoy a higher standard of living -as there are genuinely more products in the market that can be produced at lower prices, as opposed to less money.

11/21/2008 10:18:00 pm  

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