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Deflation shifts the returns, making holding cash more attractive, so it reduces investment. Reduced investment likely results in lower long term growth as less

Deflation shifts the returns, making holding cash more attractive, so it reduces investment. Reduced investment likely results in lower long term growth as less new businesses and ideas can be funded.

deleted 12y ago
[deleted]
gfodor 12y ago
Deflation effectively increases the risk free real rate. So the same effect of seeing the rate on the 10yr rise will be seen with disinflation. The difference being that you get some yield for "free" by just holding the cash and not buying bonds, but this is just incidental. The effect on risk-taking should be the same. So the point is I don't understand why it's treated as a deathblow for investment when we accept interest rate rises all the time without widespread panic about investment coming to a halt.
- harryh 12y ago
  Cash you spend on buying bonds is actually being put to use by someone. Cash you stuff under your proverbial mattress isn't.
- ChrisLomont 12y ago
  There is a huge difference between interest rate changes, which are set in large part by the Fed, versus deflation, which is not set by the Fed. The return on a 10yr (govt bond I assume?) is set by the market - this is not just picked or changed arbitrarily, although returns there are likely influenced by Fed rates. People control the interest yield for many products through the Fed, so we can avoid a deflationary spiral just by having the Fed change the interbank loan rate (among other things they can do). Deflation (caused by many types of things from demand shocks to economic fears to war) is often not easily dialed back, and can lead to a deflationary spiral, which cannot be simply tuned by the Fed. This is the reason the Fed targets slight inflation instead of zero inflation; the controls are not magic and the inflation/deflation tends to hover around where the Fed targets, and by staying away from zero we avoid possibly triggering a deflationary spiral we cannot control. In short, we have good tools for dealing with inflation. We do not have equivalently good tools for dealing with deflation.

deleted 12y ago

[deleted]

gfodor 12y ago

Deflation effectively increases the risk free real rate. So the same effect of seeing the rate on the 10yr rise will be seen with disinflation. The difference being that you get some yield for "free" by just holding the cash and not buying bonds, but this is just incidental. The effect on risk-taking should be the same. So the point is I don't understand why it's treated as a deathblow for investment when we accept interest rate rises all the time without widespread panic about investment coming to a halt.

harryh 12y ago
Cash you spend on buying bonds is actually being put to use by someone. Cash you stuff under your proverbial mattress isn't.
ChrisLomont 12y ago
There is a huge difference between interest rate changes, which are set in large part by the Fed, versus deflation, which is not set by the Fed. The return on a 10yr (govt bond I assume?) is set by the market - this is not just picked or changed arbitrarily, although returns there are likely influenced by Fed rates. People control the interest yield for many products through the Fed, so we can avoid a deflationary spiral just by having the Fed change the interbank loan rate (among other things they can do). Deflation (caused by many types of things from demand shocks to economic fears to war) is often not easily dialed back, and can lead to a deflationary spiral, which cannot be simply tuned by the Fed. This is the reason the Fed targets slight inflation instead of zero inflation; the controls are not magic and the inflation/deflation tends to hover around where the Fed targets, and by staying away from zero we avoid possibly triggering a deflationary spiral we cannot control. In short, we have good tools for dealing with inflation. We do not have equivalently good tools for dealing with deflation.