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A persistently deflationary economy would be horrible: When everyone expects prices to fall in the future, everyone becomes less willing to spend today. Sittin

by cs702 12y ago

A persistently deflationary economy would be horrible: When everyone expects prices to fall in the future, everyone becomes less willing to spend today. Sitting on cash becomes an investment with a positive yield. The less everyone wants to spend on goods and services, the less businesses sell of everything, and the more they have to compete by lowering prices further, making everyone less willing to spend... a vicious circle of economic contraction. Businesses normally find it very, very difficult to cut employee compensation in line with declining prices, so they end up cutting costs by firing people instead, making everyone less willing to spend, so businesses sell less of everything, forcing them to cut costs futher... contributing to the vicious circle of economic contraction. A deflationary economy is a negative-sum game in which everyone loses.

nowey 12y ago
>When everyone expects prices to fall, everyone becomes less willing to spend I find that contradictory. If something becomes cheaper, I will be more likely to buy it. It's the entire reason to have discounts and sales. Slippery slope fallacy?
- howlin 12y ago
  Sure it's cheaper, but if you wait another month it will be even more cheap. The longer you can hold of spending, the more you get for your money. Contrast that to a sale. During the sale, things are cheap now with the expectation they'll be more expensive later. Holding on to your money is now costing you buying power.
  - gitah 12y ago
    By that logic why do people buy iPhones? They can wait another year and get the same model cheaper or get a much better one for the same price. The iPhone 6 just had record sales so empirically there are other factors for consumer purchases that are stronger than the "waiting for items to be cheaper" factor.
  - brc 12y ago
    It is a fallacy because most consumption can only be postponed for an indefinite amount of time. If I need a fridge because my old one is broken or I just moved house, then I need a fridge. I'm not going to go without for 6 months because I think fridges will be cheaper then. We all purchase phones, computers, cars and sofas knowing that, in x months time, it's likely that the same item will be cheaper or same price but with more features. It is true that major investments like new factories might conceivably become cheaper but this also ignores opportunity cost - in the same way, with inflation, new factories are more likely to become more expensive, so it's logical to think that in inflationary times, the countryside will be dotted with idle factories built as a hedge. This doesn't happen because of a variety of factors, not the least of which is that people make investments because they expect to see a big margin difference between keeping the cash and having that investment make cash for them. You don't built a new factory because you think you'll make 3% more than bank interest, you do it because you think you'll make 20-50% return on the cash. The deflationary spiral postponed purchases explanation is a bit like the efficient market hypotheses - plausible sounding but ultimately and empirically not true in practice.
gfodor 12y ago
This is the standard story about deflation, but the idea that a slightly deflationary environment will suddenly change purchase behavior has always struck me as a bit academic. The average consumer doesn't buy stuff because they think inflation is going to cause it to become more expensive in the future, they buy stuff because they need it. It seems borderline absurd to suggest that consumers are going to reconsider buying something because in a year it will be a few % cheaper in price. However, I do agree that a persistent deflationary economy (and the corresponding expectations that it will continue) will have... interesting effects on interest rates, debt, and corporate spending. But I still am not sold on the idea that it's a de facto negative thing. I think saying "deflation = bad" oversimplifies the lessons to be learned from the Great Depression but unfortunately that's the lesson we're taught.
- harryh 12y ago
  Of course it won't change consumer behavior for everyone all the time. At some point I'm just gonna have to buy that dishwasher. But it will change consumer behavior at the margin and what happens at the margin is what economic thinking is all about. Also, it's not just about consumer behavior but also investor behavior. Why should I take the risk of investing my money in a new product or company if I can earn a profit by hiding my money under my mattress?
  - gfodor 12y ago
    On your former point I actually agree, but that's not the way the 'deflation = bad' argument is usually presented. It's usually presented that "people will defer purchases", full stop, and that would be terrible but it's hard to believe. I agree it will happen on the margins, but that might not be a huge deal. Investment wise, it always comes down to risk and inflation adjusted returns. Hiding your money under your mattress results in a risk free positive real return in a deflationary environment, but this just the same as buying a short term treasury bond. It's self evident that just because you can get a risk free positive return, it doesn't mean capital won't take on risk for a higher one. If that were the case, nobody would invest in anything other than government bonds.

by cs702 12y ago

nowey 12y ago

>When everyone expects prices to fall, everyone becomes less willing to spend I find that contradictory. If something becomes cheaper, I will be more likely to buy it. It's the entire reason to have discounts and sales. Slippery slope fallacy?

howlin 12y ago
Sure it's cheaper, but if you wait another month it will be even more cheap. The longer you can hold of spending, the more you get for your money. Contrast that to a sale. During the sale, things are cheap now with the expectation they'll be more expensive later. Holding on to your money is now costing you buying power.
- gitah 12y ago
  By that logic why do people buy iPhones? They can wait another year and get the same model cheaper or get a much better one for the same price. The iPhone 6 just had record sales so empirically there are other factors for consumer purchases that are stronger than the "waiting for items to be cheaper" factor.
- brc 12y ago
  It is a fallacy because most consumption can only be postponed for an indefinite amount of time. If I need a fridge because my old one is broken or I just moved house, then I need a fridge. I'm not going to go without for 6 months because I think fridges will be cheaper then. We all purchase phones, computers, cars and sofas knowing that, in x months time, it's likely that the same item will be cheaper or same price but with more features. It is true that major investments like new factories might conceivably become cheaper but this also ignores opportunity cost - in the same way, with inflation, new factories are more likely to become more expensive, so it's logical to think that in inflationary times, the countryside will be dotted with idle factories built as a hedge. This doesn't happen because of a variety of factors, not the least of which is that people make investments because they expect to see a big margin difference between keeping the cash and having that investment make cash for them. You don't built a new factory because you think you'll make 3% more than bank interest, you do it because you think you'll make 20-50% return on the cash. The deflationary spiral postponed purchases explanation is a bit like the efficient market hypotheses - plausible sounding but ultimately and empirically not true in practice.

gfodor 12y ago

This is the standard story about deflation, but the idea that a slightly deflationary environment will suddenly change purchase behavior has always struck me as a bit academic. The average consumer doesn't buy stuff because they think inflation is going to cause it to become more expensive in the future, they buy stuff because they need it. It seems borderline absurd to suggest that consumers are going to reconsider buying something because in a year it will be a few % cheaper in price. However, I do agree that a persistent deflationary economy (and the corresponding expectations that it will continue) will have... interesting effects on interest rates, debt, and corporate spending. But I still am not sold on the idea that it's a de facto negative thing. I think saying "deflation = bad" oversimplifies the lessons to be learned from the Great Depression but unfortunately that's the lesson we're taught.

harryh 12y ago
Of course it won't change consumer behavior for everyone all the time. At some point I'm just gonna have to buy that dishwasher. But it will change consumer behavior at the margin and what happens at the margin is what economic thinking is all about. Also, it's not just about consumer behavior but also investor behavior. Why should I take the risk of investing my money in a new product or company if I can earn a profit by hiding my money under my mattress?
- gfodor 12y ago
  On your former point I actually agree, but that's not the way the 'deflation = bad' argument is usually presented. It's usually presented that "people will defer purchases", full stop, and that would be terrible but it's hard to believe. I agree it will happen on the margins, but that might not be a huge deal. Investment wise, it always comes down to risk and inflation adjusted returns. Hiding your money under your mattress results in a risk free positive real return in a deflationary environment, but this just the same as buying a short term treasury bond. It's self evident that just because you can get a risk free positive return, it doesn't mean capital won't take on risk for a higher one. If that were the case, nobody would invest in anything other than government bonds.