4 ms·

I think I follow, but if my $1 today is worth $1.10 in a year, deflation, at 0% interest, that is still 10% more value year to year for the bank making the loan

by sosuke 12y ago

I think I follow, but if my $1 today is worth $1.10 in a year, deflation, at 0% interest, that is still 10% more value year to year for the bank making the loan. So $360 of money at the end of a 30 year loan, $1 per month, is worth $2,171.32 dollars in the end. That last $1 payment would be worth $209.39 dollars from the starting point. Isn't the loan still worth giving? My math is no doubt horribly off, but if each $1 is worth more that the end of the loan, deflation, or if I'm instead paying out more than $1 per month at the end of the loan, inflation, why is the deflated $1 worth less in a relative world view. Is the interest lost from inflation equal the value gained from deflation?

msandford 12y ago
Yeah it's a totally crazy concept. What you have to do is stop thinking about how many dollars a dollar will be worth, but think about the idea of purchasing power. So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff. If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc). That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not. The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly. I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.

by sosuke 12y ago

msandford 12y ago

Yeah it's a totally crazy concept. What you have to do is stop thinking about how many dollars a dollar will be worth, but think about the idea of purchasing power. So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff. If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc). That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not. The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly. I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.