Deflation - not a bad thing?

Good article. I am referencing Bank-Credit deflation to be certain and cash building deflation to a lesser extent.

 

its say constant deflation, not constant money supply. Do you understand?

 

you don't want prices falling you basically want them constant so people can learn and compare prices, and, you don't want land homes investments etc deflating so that nobody wants them.

 

I explained in my post why it is inherently detrimental for the economy and most folks. Did you read my post?

1. Cash becomes an independent investment vehicle. Cash provides a means of facilitating transaction with a common measure of value. In an inflationary environment, it doesn't make sense to hold a lot of cash because it is losing value, so you invest it, which is good for the economy. In a deflationary environment, cash gains value over time. It thus becomes and independent investment vehicle, which makes investment (or lending) a less attractive alternative.

This encourages hording of money. We are seeing this in our currently very low inflation environment. Banks and companies and the wealth are sitting on trillions in cash that they are not investing. With inflation so low that the devaluation of your cash is nil, there is less incentive to invest the money in business expansion, especially when we have low demand.

2. Deflation makes borrowing more expensive. You touched on this above. If a dollar has more value in a year, it increases the cost of borrowing in real terms. A lender (bank or otherwise) is not going to lend you money just to have the same amount repaid. Whether inflation or deflation, the lender wants more money back than it lends. So if you borrow $1000 and there is 10% deflation, you have to pay back $1000 (that now costs 10% more in real terms) plus the premium/risk for lending.

Also, with incomes and property values falling, lenders are facing more risk and are going to be more cautious about lending when incomes are falling and the value of its security is falling. Lenders will be willing to lend a smaller portion of the asset or business plan proposed.

With a higher cost and greater risk, lending becomes more expensive and less obtainable. Devastating to the economy, but particularly to industries such as housing and auto manufacturing where most folks finance their acquisitions and otherwise cannot afford them.

3. Fixed costs increase in real terms. For the scores of millions who owe on loans for a home, care, education or CC, the real costs of the payments increase as inflation decreases income. A $1500 a month mortgage may be enough to handle when you make $30,000, but has your income decreases, that mortgage payment becomes a bigger and bigger burden. And additionally, the value of your asset (home, car, etc.) is losing value.

We saw this with the housing crash, where falling property values and the recession left millions holding property assets that dropped in value as their incomes declined. They had a harder time paying their mortgages (causing millions of defaults) and their house values often fell below the amount they owed on their mortgage, meaning they couldn't sell. The result was catastrophic to the economy.

These are reasons why deflation is viewed as a bad thing.

Of course. I explained your logical errors. Did you not read my post?

Your point is faulty based on the false presumption that deflation does not affect incomes (which ironically you acknowledged in your next point.)

If you have deflation, the price of everything falls, including workers' salaries.

If you made $30,000 and the price of a gallon of milk is $3, and after deflation you make $27,000 and the price of a gallon of milk is $2.70, you haven't affected your purchasing power at all.

You are making the same logical error, as I explained in my previous post.

Same logical error as point 1. Business costs decrease but so does their revenues and incomes.

There is no real decrease in business cost from deflation, just as there is no purchasing power gain.

I'm not sure what that has to do with deflation. That could be the case with inflation as well.

Again, I'm not sure what this has to do with deflation.

That's fine where one bank goes bad because of bad policies or actions. The problem is that a systematic failure of major financial institutions brings the entire economy down with it.

Well of course you prefer successful investment over bad. But you don't have successes without some failures. The answer is not to severely limit investment potential, which con inhibit economic expansion.

The secondary market in mortgages exists outside of F/F, in fact, they were falling way behind in the mid 2000s and rushed to get in on the action, at just the wrong time.

Remove regulations and lending rules is a recipe for disaster, we've seen it every time we've tried it.

There is no increase in purchasing power where incomes are falling with deflation.

Your point doesn't "unravel" my assertion at all. (1) you persist with the false belief that deflation increases purchasing power, and (2) you did not address the numerous negative elements deflation imposes on the economy as set forth in my post.

Why would any lender lend $100 today to get back $98 in the future? Whether deflation or inflation, that makes no sense.

However, deflation does increase the real cost of borrowing, as I explained in my post.

That is always so, regardless of the price levels.

Irrelevant re: deflation. These same forces are in play whether we have inflation of deflation.

It is true that people with fixed incomes will benefit from deflation. And those paying the fixed incomes (including the Govt) face rising real costs.

However, there is little economic justification to give such a windfall to those receiving fixed incomes.

You can adjust the income for inflation/deflation, such as is done with SS and many pensions.

 

I read your post. I'm grateful to have the discussion. You made some great points but we are not on the same page on the deflation increasing purchasing power point. I'm going to comment on that piece and see where we get (not ignoring your other concerns, but this seems reasonable place to start).

Deflation does increase purchasing power:

By conflating savings and wages and only recognizing the fall of one without recognizing the impact of the rise in the other, you may not be considering all angles of deflation. For what you are saying to be true, that deflation does not increase purchasing power, you would also have to say inflation does not decrease buying power either. If this is the logical error I made, I would say millions of people are also making the same logical error. But it is not other's opinion that make something true or false.

Take this deflationary scenario: It's the first day of the year. Prices will fall 1% each month calculated at the end of the month. You get paid your wage twice a month. The wages you make each previous month buy more and more goods the following months. We must assume these individuals will be predisposed to saving right? That is the basis for the deflation is bad argument. Rightfully so, you state people will 'horde' their money. Rightfully so, you state that cash becomes an investment. What is happening to that cash being accumulated? All the cash is increasing in purchasing power. Each month, it compounds by 1%.

In order for this not to be true, you would have to have a 0 savings rate, which, as we both pointed out, is unlikely...impossible if you expect people to horde.

We see falling wages and increasing purchasing power...they are not mutually exclusive concepts and do not contradict each other...therefore there is no logical error. Where do you see the error?

 

because with prices going down there is no incentive to do anything today and the economy collapses.

 

Let's make the point more specifically because you are making an overbroad statement. Deflation increases the purchasing power of a dollar.

Whether purchasing power of an individual or in in the economy overall increases is a function of income relative to the prices of goods and services. If incomes go up faster than the price of goods and services, you have an increase in purchasing power in the economy, despite there being inflation. If incomes go down faster than the the decrease in prices, you have a decrease in purchasing power in the economy despite there being deflation.

Wages and income can change relative to the prices of goods and services just as the prices for goods and services can change relative to each other. Purchasing power can therefore increase or decrease whether there is inflation or deflation.

You cannot make a generalized statement that deflation increases purchasing power, because, all other things being equal, incomes will decrease as well.

I pointed out in my initial post that deflation increases the relative value of a dollar, and therefore makes the dollar an independent investment vehicle, which, for reasons I stated, is bad. It encourages hoarding over investment, makes the cost of borrowing more expensive, and inhibits economic expansion, among other things I mentioned.

This is where you make your error. You are making an assumption that the prices for goods and services fall, but incomes or wages do not. In a deflationary environment, incomes must fall, unless there is a real increase in wages/incomes. If there is a real increase in wages and incomes, then purchasing power increases. This is true whether there is deflation or inflation. If prices go up 10% and wages/income increase 20%, you have more purchasing power.

I agree that if you make an assumption that real wages/income increase, then real wages/income increase. But that is based on an assumption that is independent of whether there is inflation or deflation.

Take a scenario where prices decline 1% each month and wages/income decreases 2% each month. Has there been an increase in purchasing power? No, there has not.

But you are taking an erroneous position that deflation only affects the prices of goods and services but not incomes.

Again, you are making an erroneous assumption that deflation does not affect incomes. It does, just as inflation does.

That is backwards. If you have a real increase in income, you will have a real increase in purchasing power.

People will save less if their real incomes are decreasing. If their real incomes are steady, the savings rate wouldn't change, ignoring other factors.

I agree that deflation will change the incentive to hoard dollars versus invest. As I explained in my first post, if there is inflation, the dollar has no independent investment value, and people will lend/invest to get a return to offset the effect of inflation.

If there is deflation, the dollar has independent investment value, because it is increasing in value. Other investments become less attractive, and lenders/investors will require higher real returns, which makes the cost of borrowing more expensive, which inhibits economic activity and growth.

As I've explained several times now, your error is your assumption that wages/incomes don't decrease when you have deflation.

 

People still need to buy stuff. Whether they may be incentivized to wait depends upon their expectations as to future income. If you expect your real income to increase, you're more likely to buy things. If you expect your real income to decrease, the opposite is true. Irrespective of inflation or deflation.

 

The exchange value of goods are inverses of each other. They both can't go down. If the price of an apple falls from 2 oranges to 1 orange, the price of an apple has to increase from 1/2 orange to 1 orange. It's impossible for the price of everything to go down, because prices represent the relative values of goods, so that we can be efficient in choosing how use our scarce means.

 

It is absolutely possible for the price of everything to go down. That is what deflation is. Prices represent the relative value of goods, but in dollars. If there are fewer dollars in the economy, prices go down generally.

 

If money supply is cut in half all prices are cut in half but a car still will cost more than a bike. 1+1=2

- - - Updated - - -

dear, if you expect prices to fall you have every incentive to wait regardless of income. This is Econ 101 class one day one and it is why the Fed does not allow deflation. Got it now?????

 

So the price of dollars goes up. See inverse movement.

If loaf of bread exchanges for $2 today and next year a loaf of bread exchanges for $1, the price of a dollar relative to a loaf of bread doubled.

- - - Updated - - -

And the price of a dollar would have doubled. So not all prices went down. Prices went up and down.

 

do you have any idea what your point is????

 

Yes, my point is that what you said is impossible. All prices cannot go down.

 

so if money supply is cut in half all prices won't go down???????????

 

Nope. Not all prices will go down, the price of a dollar will double.

 

Iriemon - we are talking past each other...

I never assumed wages held constant. They don't need to hold constant for dollars to be more powerful. If prices fall, the dollar buys more. That is a general economic statement and has nothing to do with the relative wealth of an individual. For individuals, if they owe a lot of debt, falling prices and wages will hurt. If they are on a fixed income, it's time to celebrate. Everyone's individual welfare will be unique to them. What I can say is, as long as people save, the dollars they accumulate increase in value month after month.

In the scenario I described, when prices fall 1% each month, your wage doesn't fall until the CPI falls. They both fall each month. However, you are saving each month, so whatever money is saved increases in value.

 

so why so afraid to tell us why you think not all prices will go down??? What does your fear teach you?

 

if prices fall wages do too. Why not try to say what your point is??

 

Not if you expect your income to fall by more than half. Got it now???

I'm not your "dear" and sorry, I'm not gay.

- - - Updated - - -

And the price of a loaf of bread, and everything else, has gone down.

Thanks for demonstrating my point.


And the price of a dollar would have doubled. So not all prices went down. Prices went up and down.[/QUOTE]

 

No. The price of everything didn't go down. The price of dollars went up.

- - - Updated - - -

Not all prices will go down. The price of the dollar will go up.

 

I don't think we are at all. I've demonstrated the fallacy in your entire argument. Your entire position was premised on the position that with deflation, prices go down, but your income remains the same, giving more purchasing power. I've pointed out the fallacy in your position is based on the fallacious presumption that wages/income will not decrease equivalent to the level of deflation.

Therein lies the fallacy of your position. Your making an assumption that incomes fall less than prices. If your income/wages go down by the same percentage as prices decline, you have no increase in purchasing power. And with your wages/income going down, you have no more money to save that you did before. Less, actually, because your discretionary income is decreasing proportionally, even if you have no fixed expenses.

Inflation or deflation do not change relative purchasing power because it affects wages/income (which are just prices as well) the same as any other price.

All that matters is the change in relative income to prices.

If you have 1% inflation and your income/wage increases 2%, you have more purchasing power.

If you have 1% deflation and your income/wages decreases 2%, you have less purchasing power.

Which is meaningless as you have less dollars to spend.

Since they have less money to save, they are in no better position than they were before.

Yes, people with fixed incomes benefit. I asked before, what is the overall economic benefit to giving people with fixed incomes a windfall increase in their income, when everyone who has a mortgage or a car loan is disadvantaged because of that?

 

Deflation or inflation is the overall prices of goods and services, not dollars. The price of a dollar is still a dollar.

That's like saying that when the prices of everything goes up -- inflation -- it's the price of dollars going down.

No, the price of a dollar is still a dollar.

 

Exactly. By increasing the supply of dollars, and therefore lowering the price of dollars, the prices of everything relative to dollars goes up.

Yes, and the price of a pumpkin is still a pumpkin. But why would anyone exchange a dollar for another dollar.

But the question is: How many pumpkins does a dollar cost? How many Coors Lights does a dollar cost. Dollars have a price. People buy them all the time. In fact, you probably buy dollars in exchange for your labor, no?

 

Inflation. And since the price of everything goes up, you can have the price of everything go down.

No, the price of a pumpkin is is about $.45/lb. You don't buy pumpkins with pumpkins.

No, the question is, if you have price deflation does the price of everything decrease.

Which we've already established.