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Saturday, November 22, 2008

Deflation

So this article spells it out better than most, but I'm still a little confused.

Could somebody give me a better idea why deflation is a bad thing? Feel free to use analogies as necessary, but please, refrain from any appeal to authority, even a basic one like "everyone knows deflation would be horrible."

I'm curious, because I'm sort of a cash & carry sort of guy. My savings aren't huge, but they're still ahead of my debt, so I'm trying to get a better handle on why this is always viewed with such stigma.

4 comments:

consumatron said...

To me, it's not a failure of a system or even of a currency or economy. It's a failure of imagination and a stubborness in which the definition of economic success is continued growth.

GDP and general business culture doesn't necessarily take into consideration the actual cost of things... which is what real economics should do. After all, economics is the study of resources and need, not just currency and capital.

We've believed ourselves into a corner where more is better, but every "more" in the national/world checkbook makes a "less" in the world resources.

The whole "green" culture hype is a positive step in the right direction at its core, but still extremely misled and geared toward creating alternative structures that are similar to the existing ones. Stock holders don't want the green culture to decrease costs for people, they want it to create more streams of growth while the old streams stagnate... but god forbid decrease.

I agree, deflation is not a bad thing. But unless we all change our economic religion and start focusing on more than the "bottom line" (like the true cost bottom line), it's going to feel really bad.

Growth in a child is a good thing, but unless you get that child some new clothing, you're going to cut off circulation.

Our economic clothes don't fit anymore.

How's that for an analogy?

Paul Benjamin said...

The issue with deflation is that it self feeds, inflation whilst "costly" eventually self corrects as people can no longer afford to consume more and the more profitable (in marginal terms) companies produce more.

Deflation however makes people want to defer their consumption, expecting prices to fall. By deferring consumption companies feel compelled to cut prices, offer sales and promotions. Consumers will then think that prices will fall again if they can hold out a little longer, deferring consumption yet further.

Expected and consistent deflation is a major issue for an economy and can really only be dealt with by a fiscal injection.

transiit said...

@consumatron It seems to me that a Net Domestic Profit would better account for technological advances, long term impact, etc., but defining "overhead" to subtract from GDP isn't terribly simple.

@paul At least around these parts, we're coming down from an idea that things can only get better. I can see how a market could set up a feedback loop in which they're always holding off from lower prices because they might just be a bit lower tomorrow. But..I'm staring down years of people saying "we'd better buy now, because we won't have that kind of money soon, besides, it might be more than it's worth, but as long as things keep going, we can sell it at a profit if we have to."

@both
I'm thinking a lot about what a ratcheting economy means (easier to turn one way than the other), and both the optimistic and pessimistic views sort of trouble me in that they both believe the economy isn't terribly self-governing. I kind of like the idea of an invisible hand (even if it slaps people around from time to time) I think what worries me the most is when the participants in the market develop a sense of entitlement. Like it's their turn to become fabulously wealthy, and anything that doesn't immediately address that is a problematic idea.

Granted, I've heard a lot of arguments offline talking about how deflation hurts people that are in debt (because the shekel they owe could cost more than the shekel they spent), but I'm quickly approaching a point where I haven't a lot of sympathy for anyone that goes into debt expecting inflation upon their side. That today's hamburger will only cost a fraction of hamburger by the time they pay it off on tuesday.

I worry that this "deflation is horrible. avoid deflation. do not want." vibe is based upon a system intent that their expenditures are justified based not on value, but that it'll be easier to pay off in the future.

Paul Benjamin said...

The other big problem with deflation which gets a bit technical, comes from the fact that most people do not understand the difference between real and nominal wages.

Most people are happy if their wages rise every year regardless of the amount that those wages can in fact buy, conversely if you start to talk to people about pay cuts, there is mass hysteria and the unions get involved.

John Keynes spoke of inflation as being the grease which kept the labour market working. In an inflationary economy it is easy to cut real wages by giving a lower than inflation nominal pay increase. However in a deflationary economy, such as the one we are currently staring down, wages will almost certainly have to stay the same nominally, and will in fact cost the company more in real terms.

Given that companies are currently hurting and need to cut costs, they would have a lot more room to maneuver in an inflationary evironment than a deflationary one.

Really though the current crisis, and I don't use that word lightly, is about the failure of the credit market. Which coupled with deflation making borrowing *even* more expensive will start to hurt investment, which in turn will lower production in the future, leading to lower investment and so on until we are back to subsistence farming.