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Deflation is bad because - you earn a rate of return on simply sitting on money. Doing nothing competes with investing. If deflation is 5%, why bother making a

Deflation is bad because - you earn a rate of return on simply sitting on money. Doing nothing competes with investing. If deflation is 5%, why bother making an investment that could return 5%? Why does a rich person deserve to earn a rate of return on their wealth for nothing? - deflation incentivizes non-spending. People will delay purchases if they expect prices to decrease in the future. - deflation necessitates nominal pay cuts. People are psychologically unwilling to accept pay cuts. This leads to layoffs, strikes, labor unrest. - deflation necessitates a decrease in nominal aggregate income. Your savings growing by 2% sounds nice, but most people's cash savings is a tiny fraction of their future income. Your income will go down. Own any stocks? Those could decrease in value every year. - deflation increases the cost of debt. How would you like it if your credit card debt or student loan debt grew by 2% every year?

BlackFly 11y ago
These points seem rational but seem more and more superficial as I think about them. - A 5% return on an investment coupled with 5% deflation is equivalent to about a 10.5% return. Economically ideal rational actors will continue to invest. - The majority of purchases people make are not delayable: utility fees need to be paid if you wish to continue receiving them, food must be purchased, renting is money thrown in the garbage as is. Everything else that people have to save for, they will normally purchase the minute they are able because they feel the vacuum. - Necessity of pay cuts doesn't follow from deflation but rather from depression. Unlike the other points you don't attempt to defend this premise. - Repeat of prior point. - The debt won't grow. The normal argument should be that your salary will decrease by 2% each year so effectively the original principle grows, but this is an effect of depression, not deflation. The idea that deflation leads to depression is because people argue that it will lead to non-spending. However, my experience with real people, as opposed to theoretically idealized "rational" actors tells me that the minute they can afford to spend more, they will. The evidence on people winning the lottery is similar: most people do not invest, but rather spend quickly and emphatically.
- evanpw 11y ago
  I think you're mixing up real (inflation/deflation-adjusted) and nominal (not inflation-adjusted). - nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0. But it seems more likely to me that the real return of any particular investment opportunity would remain relatively constant rather than the nominal return. I'm not too sure about this one - I think that a majority of investment decisions (in dollar terms) are made by people not living paycheck-to-paycheck. I think you still might be right in practice, though - If there's deflation of 2%, then to pay your employees the same amount in real terms, you have to cut their nominal pay by 2%, which people really dislike - This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes - Debts are usually measured in nominal terms, so if you have a loan that says $100 but that $100 is now worth 2% more than it was before, your debt has increased in real terms
  - PantaloonFlames 11y ago
    > nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0. What nerfhammer meant was that a 5% deflation is EQUIVALENT to a 5% nominal rate of return in a 0% inflation market. In other words, during deflation, sitting on cash makes the cash more valuable. Deflation is a dis-incentive to invest, share money, start projects, or seek profits.
    - evanpw 11y ago
      Excellent point. In other words, if you can earn a 5% (real) risk-free return by stuffing $100 bills under your mattress, you're much less likely to make a risky investment expected to make a 6% (real) return, and definitely won't make any investments earning 4%.
  - nerfhammer 11y ago
    > This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes The difference is you would be better off holding cash. The stock's value is constant in real terms, the value of cash increases.

BlackFly 11y ago

These points seem rational but seem more and more superficial as I think about them. - A 5% return on an investment coupled with 5% deflation is equivalent to about a 10.5% return. Economically ideal rational actors will continue to invest. - The majority of purchases people make are not delayable: utility fees need to be paid if you wish to continue receiving them, food must be purchased, renting is money thrown in the garbage as is. Everything else that people have to save for, they will normally purchase the minute they are able because they feel the vacuum. - Necessity of pay cuts doesn't follow from deflation but rather from depression. Unlike the other points you don't attempt to defend this premise. - Repeat of prior point. - The debt won't grow. The normal argument should be that your salary will decrease by 2% each year so effectively the original principle grows, but this is an effect of depression, not deflation. The idea that deflation leads to depression is because people argue that it will lead to non-spending. However, my experience with real people, as opposed to theoretically idealized "rational" actors tells me that the minute they can afford to spend more, they will. The evidence on people winning the lottery is similar: most people do not invest, but rather spend quickly and emphatically.

evanpw 11y ago
I think you're mixing up real (inflation/deflation-adjusted) and nominal (not inflation-adjusted). - nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0. But it seems more likely to me that the real return of any particular investment opportunity would remain relatively constant rather than the nominal return. I'm not too sure about this one - I think that a majority of investment decisions (in dollar terms) are made by people not living paycheck-to-paycheck. I think you still might be right in practice, though - If there's deflation of 2%, then to pay your employees the same amount in real terms, you have to cut their nominal pay by 2%, which people really dislike - This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes - Debts are usually measured in nominal terms, so if you have a loan that says $100 but that $100 is now worth 2% more than it was before, your debt has increased in real terms
- PantaloonFlames 11y ago
  > nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0. What nerfhammer meant was that a 5% deflation is EQUIVALENT to a 5% nominal rate of return in a 0% inflation market. In other words, during deflation, sitting on cash makes the cash more valuable. Deflation is a dis-incentive to invest, share money, start projects, or seek profits.
  - evanpw 11y ago
    Excellent point. In other words, if you can earn a 5% (real) risk-free return by stuffing $100 bills under your mattress, you're much less likely to make a risky investment expected to make a 6% (real) return, and definitely won't make any investments earning 4%.
- nerfhammer 11y ago
  > This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes The difference is you would be better off holding cash. The stock's value is constant in real terms, the value of cash increases.