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Regarding your point about the lending vs borrowing: The use of the word "encouraged" makes sense to me. If people are "encouraged" to lend vs borrow, that mea
by scrollbar 13y ago
Regarding your point about the lending vs borrowing:
The use of the word "encouraged" makes sense to me. If people are "encouraged" to lend vs borrow, that means they will have more desire to lend vs borrow. This has an important effect on the supply vs. demand equation. Supply of loans, ie. people willing to borrow, goes down and the demand, ie. people willing to pay money now for interest later, goes up, causing prices (interest rates) of loans to go up (down).
In other words even though every dollar lent must be a dollar loaned, people's willingness to lend affects supply and demand.
- saalweachter 13y agoA deflationary currency doesn't encourage people to lend, it encourages them to save. If currency is deflating at a low, constant rate (say, 2-3%, comparable to the normal rate of inflation), then the interest rate -- in real terms -- must be strictly higher than this. A 0% loan with 2% deflation the equivalent of a 2% real interest rate. But no one will ever lend money in this situation. You take on risk, but have no reward. So the rate of deflation is the minimum real interest rate of any loan in a deflationary currency. In an inflationary currency, people will lend out money at even a negative real rate of interest and effectively lose money on an investment because the alternative is losing even more money by holding cash. If inflation is 2%, you will consider lending out money at 1% interest (if that is your only choice) because getting 99 cents back on your dollar by investing is better than getting 98 cents back on your dollar by holding cash. Hence, an inflationary currency encourages both lending and borrowing: lenders lose less real money than holding cash, borrowers pay back less real money than they borrow. A deflationary currency encourages neither: lenders would prefer to hold cash, because it's safer and has decent returns, and borrowers have even higher real interest rates.
- scrollbar 13y agoYep, thanks for the clarification, I don't disagree but just taking issue with parent's point that dollars lent = dollars loaned therefore it's impossible for policies to affect lending rate.
- Andrew_Quentin 13y agoI don't think your maths is correct. If the currency is deflating at 2%, it is deflating regardless of whether it is the lender or the borrower holding it. If therefore this is lent at 1%, the real return is 3%, 2% by deflation, 1% through the interest rate. Hence it is more profitable to lend than hold.
- mikhailfranco 13y agoInflation also triggers higher taxes, because you pay on nominal amounts not real amounts. So 2% inflation plus 2% real interest rate, you pay income tax on total 4% rate, not 2%. Same with capital gains, you buy and hold something that keeps its real value, and you end up paying capital gains when you sell it, because inflation has pushed the price up.