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Interest rates are low because inflation is low and central banks are irrationally terrified of even mild deflation, fearing some sort of hypothetical deflation

Interest rates are low because inflation is low and central banks are irrationally terrified of even mild deflation, fearing some sort of hypothetical deflationary spiral (despite a complete lack of precedent). And since the rate of technological progress is increasing, and technological progress creates deflationary pressure, they have to work extra hard to keep up. Tell me, when was the last time you stopped buying milk because you noticed housing prices coming down? Or stopped buying cars because you notice that coffee is getting cheaper? Hell, when was the last time you stopped buying coffee when you noticed coffee getting cheaper? We really need to start challenging the idea that mild inflation is the only acceptable monetary policy. At the very least, when considering the scariness of some degree of deflation, we should use an inflation metric that excludes consumables (as proven in repeated rounds of econometric studies that consumable items have no decrease in purchasing rates during downward pricing trends, and in fact have statistically significant increases in purchase rates).

Mikeb85 12y ago
The problem with deflation isn't that everyday things get cheaper, it's that investments (like houses) devalue, which leads to people hoarding cash. Now that's not to say it's always a bad thing. In Canada right now I'd argue houses are way too expensive, and that market needs to correct itself. If housing prices were to crash (and they very well might), they'd eventually bottom out at a reasonable level, because many people who held off buying a house when then buy one. However if deflation happened year after year, and everyone expected that the price of anything they bought would devalue, they might not buy it today. Enough people do that en masse, and you have problems.
- shard972 12y ago
  > and everyone expected that the price of anything they bought would devalue, they might not buy it today. I don't see how this is different than today, there are not many things you buy aside from a house that don't lose value over time.
  - RockyMcNuts 12y ago
    houses, factories, stocks, bonds, bank accounts... all generally expected to provide a positive nominal return. they provide a negative nominal return, you're better off hoarding greenbacks. the zero interest rate policy already breaks the banking system. the payments system was historically paid for just by giving the bank an interest-free loan. If the bank can't reinvest above zero, there's no value in running a branch network to collect deposits or running a payments system in exchange for some float. the whole system is on life support because the Fed provided a bank subsidy via interest on excess reserves. but the whole system, things like money market funds, CDs, they make no sense in a negative interest rate environment. how about all those people with 30-year, 80% loan to value mortgages? the value of the house goes down year after year, the real value of the mortgage and the fixed mortgage payment goes up, they're going to have a pretty bad time. how about all the (much reduced) companies and municipalities that have defined benefit pensions, or even life insurance contracts that assume a positive, relatively risk-free return? all those pension funds and insurance companies go bust. how are people going to feel about periodic reductions in their wages? people have a hard time with it, and wages and prices tend to be stickier going down than going up. constant downward pressure makes people unhappy and is hard to get used to, even if relative prices stay the same. the expectation that prices are not going to consistently go down over time is pretty hard-coded into the financial system and contracts and people's psychology, and if it happened it would cause more disruption than higher-than-expected inflation.
dageshi 12y ago
Didn't that deflationary spiral happen in Japan? The lost decade?
- msandford 12y ago
  Hasn't Japan been printing tremendous amounts of money to try and prevent it, with no end in sight? At what point does that get discredited?
  - ctl 12y ago
    That's exactly why it's called a deflationary spiral: once you're in it, it's hard to get out even with aggressive monetary policy.
    - msandford 12y ago
      Maybe the problem is that they're trying to hold asset prices up at a completely bananas level. And because it's such a crazy high level, the only way people will hold them is constant money printing. Perhaps letting the prices return to levels that are based on fundamentals instead of constant printing would solve the problem. There's no guarantee it becomes a spiral, especially if the deflation is mild. Mild deflation with zero interest rates is roughly the same as zero inflation with slightly higher rates or mild inflation and moderate interest rates. There's very little technical difference between the three so long as the delta is only 2% or so. In other words, the world wouldn't grind to a halt with 2% deflation. It's 20% deflation that causes the spiral, not 2%. Unless of course you're so heavily financialized that 2% makes all your models blow up and your banking sector is so entrenched in and around the government that they can hold an entire country -- if not the world -- hostage.
cylinder 12y ago
We also should include asset (house) prices in CPI. Yes, I understand you only need to rent to be able to have shelter, but there's clearly inflation going on, just not in the components of CPI. We can't ignore asset inflation.
joelmichael 12y ago
The Great Depression is the precedent. The money supply dropped by a third, prices for everything dropped dramatically, and much of the labor force was thrown out of work. The general understanding today held by the Fed is that it was because the Fed failed to create new money and inject it into the banking system to prevent a systemic collapse.
rpedroso 12y ago
I think the example of falling milk prices downplays the theory that deflation is harmful unfairly. Surely, if we were facing deflation, I would continue to buy milk. However, I would be seriously hesitant about borrowing money to purchase a house because the value of a dollar at the time I bought the house would be less than the value of a dollar in the future. Under inflation, the opposite is true: I pay back a loan with dollars that are less valuable than the dollars I borrowed. If you go beyond the individual prospective debtor and consider larger entities like banks and businesses, the potential economic effects of deflation appear more serious. To add to this: under continued deflation, wages would have to fall to compensate. But, as Krugman and others have pointed out, nominal wages resist downward pressure[1], which means that instead of lower wages, you get layoffs. If you get laid off, whether or not prices are falling, you might actually hesitate about buying that gallon of milk. [1] http://krugman.blogs.nytimes.com/2010/07/26/mysteries-of-deflation-wonkish/ http://krugman.blogs.nytimes.com/2010/07/26/mysteries-of-def...
- collyw 12y ago
  I am in Europe where the low interest rates are keeping housing and other assets as close to bubble prices as possible. I am waiting for them to go up, as the prices ought to come down then.
deleted 12y ago
[deleted]
tonyedgecombe 12y ago
If I thought house prices were falling I certainly wouldn't buy a house, the same goes for any other major purchase.
jfoutz 12y ago
Oil is a good recent example. the US is buying more gas than ever, but with fewer workers. I absolutely stop buying coffee when i don't have a job, regardless of price. Deflation is like that oil microcosm but with everything.
ctl 12y ago
My understanding is there are two reasons you want inflation: (1) Inflation means real interest rates can go negative, which means it's harder to get stuck at the zero lower bound (as we are today). (2) Wages are sticky, i.e. workers fight very hard against having their wages reduced. When there's inflation you can effectively cut wages by giving raises below inflation. Without inflation it's very hard to cut wages, and the economy becomes brittle.

Mikeb85 12y ago

The problem with deflation isn't that everyday things get cheaper, it's that investments (like houses) devalue, which leads to people hoarding cash. Now that's not to say it's always a bad thing. In Canada right now I'd argue houses are way too expensive, and that market needs to correct itself. If housing prices were to crash (and they very well might), they'd eventually bottom out at a reasonable level, because many people who held off buying a house when then buy one. However if deflation happened year after year, and everyone expected that the price of anything they bought would devalue, they might not buy it today. Enough people do that en masse, and you have problems.

shard972 12y ago
> and everyone expected that the price of anything they bought would devalue, they might not buy it today. I don't see how this is different than today, there are not many things you buy aside from a house that don't lose value over time.
- RockyMcNuts 12y ago
  houses, factories, stocks, bonds, bank accounts... all generally expected to provide a positive nominal return. they provide a negative nominal return, you're better off hoarding greenbacks. the zero interest rate policy already breaks the banking system. the payments system was historically paid for just by giving the bank an interest-free loan. If the bank can't reinvest above zero, there's no value in running a branch network to collect deposits or running a payments system in exchange for some float. the whole system is on life support because the Fed provided a bank subsidy via interest on excess reserves. but the whole system, things like money market funds, CDs, they make no sense in a negative interest rate environment. how about all those people with 30-year, 80% loan to value mortgages? the value of the house goes down year after year, the real value of the mortgage and the fixed mortgage payment goes up, they're going to have a pretty bad time. how about all the (much reduced) companies and municipalities that have defined benefit pensions, or even life insurance contracts that assume a positive, relatively risk-free return? all those pension funds and insurance companies go bust. how are people going to feel about periodic reductions in their wages? people have a hard time with it, and wages and prices tend to be stickier going down than going up. constant downward pressure makes people unhappy and is hard to get used to, even if relative prices stay the same. the expectation that prices are not going to consistently go down over time is pretty hard-coded into the financial system and contracts and people's psychology, and if it happened it would cause more disruption than higher-than-expected inflation.

dageshi 12y ago

Didn't that deflationary spiral happen in Japan? The lost decade?

msandford 12y ago
Hasn't Japan been printing tremendous amounts of money to try and prevent it, with no end in sight? At what point does that get discredited?
- ctl 12y ago
  That's exactly why it's called a deflationary spiral: once you're in it, it's hard to get out even with aggressive monetary policy.
  - msandford 12y ago
    Maybe the problem is that they're trying to hold asset prices up at a completely bananas level. And because it's such a crazy high level, the only way people will hold them is constant money printing. Perhaps letting the prices return to levels that are based on fundamentals instead of constant printing would solve the problem. There's no guarantee it becomes a spiral, especially if the deflation is mild. Mild deflation with zero interest rates is roughly the same as zero inflation with slightly higher rates or mild inflation and moderate interest rates. There's very little technical difference between the three so long as the delta is only 2% or so. In other words, the world wouldn't grind to a halt with 2% deflation. It's 20% deflation that causes the spiral, not 2%. Unless of course you're so heavily financialized that 2% makes all your models blow up and your banking sector is so entrenched in and around the government that they can hold an entire country -- if not the world -- hostage.

cylinder 12y ago

We also should include asset (house) prices in CPI. Yes, I understand you only need to rent to be able to have shelter, but there's clearly inflation going on, just not in the components of CPI. We can't ignore asset inflation.

joelmichael 12y ago

The Great Depression is the precedent. The money supply dropped by a third, prices for everything dropped dramatically, and much of the labor force was thrown out of work. The general understanding today held by the Fed is that it was because the Fed failed to create new money and inject it into the banking system to prevent a systemic collapse.

rpedroso 12y ago

I think the example of falling milk prices downplays the theory that deflation is harmful unfairly. Surely, if we were facing deflation, I would continue to buy milk. However, I would be seriously hesitant about borrowing money to purchase a house because the value of a dollar at the time I bought the house would be less than the value of a dollar in the future. Under inflation, the opposite is true: I pay back a loan with dollars that are less valuable than the dollars I borrowed. If you go beyond the individual prospective debtor and consider larger entities like banks and businesses, the potential economic effects of deflation appear more serious. To add to this: under continued deflation, wages would have to fall to compensate. But, as Krugman and others have pointed out, nominal wages resist downward pressure[1], which means that instead of lower wages, you get layoffs. If you get laid off, whether or not prices are falling, you might actually hesitate about buying that gallon of milk. [1] http://krugman.blogs.nytimes.com/2010/07/26/mysteries-of-deflation-wonkish/ http://krugman.blogs.nytimes.com/2010/07/26/mysteries-of-def...

collyw 12y ago
I am in Europe where the low interest rates are keeping housing and other assets as close to bubble prices as possible. I am waiting for them to go up, as the prices ought to come down then.

deleted 12y ago

[deleted]

tonyedgecombe 12y ago

If I thought house prices were falling I certainly wouldn't buy a house, the same goes for any other major purchase.

jfoutz 12y ago

Oil is a good recent example. the US is buying more gas than ever, but with fewer workers. I absolutely stop buying coffee when i don't have a job, regardless of price. Deflation is like that oil microcosm but with everything.

ctl 12y ago

My understanding is there are two reasons you want inflation: (1) Inflation means real interest rates can go negative, which means it's harder to get stuck at the zero lower bound (as we are today). (2) Wages are sticky, i.e. workers fight very hard against having their wages reduced. When there's inflation you can effectively cut wages by giving raises below inflation. Without inflation it's very hard to cut wages, and the economy becomes brittle.