Why is deflation so difficult to deal with?

[daishi5]

Also, we encourage and take deflation for granted in certain parts of our economy but are afraid of it in other parts. For example, technology lowers prices over time and everyone loves that. But no one can tolerate the lowering of house prices or their wages. Technology increases efficiency and replaces people. This is cheered until it means the loss of your job. This is a strange dichotomy that needs to be futher explored.

Hence, isn't it odd that deflation is a central part of the real economy right along with monetary expansion? The irony is rife in Japan where many young people have a temporary workers status and yet the Japanese are building robots to replace human workers.

This is not deflation, but a lowering of the actual price.

Think of price in terms of opportunity costs. I make enough money to buy 1 apple. If the price goes down, for the same amount of work, I can buy 2 apples. However, if there is deflation, the amount of money I spend on an apple goes down, but my wages also went down, so I still only make enough to buy 1 apple.

Deflation is when the number of dollars changes, but you still get the same amount of stuff, lower prices is when you can get more stuff for the same amount of work.

 

[CLite]

You can qualify it but that does not change the fact that it is still deflation. We must admit that deflation, no matter what it's called, lowers wages and kills jobs.

This is incorrect, deflation caused by increased efficiency and the lowering cost of production increases wages and creates jobs.

 

[Narmer]

Deflation is a monetary issue a lot like inflation, but it is different. The root of deflation is there is not enough money, just like inflation is too much money. The economy needs enough money to be used in every transaction in the economy. With too little money the amount of money exchanged per transaction must shrink. However, prices don't go down, so if you cannot lower the amount of money per transaction, the only other choice is to lower the amount of transactions. A lower number of transactions basically means less people working because there is just not enough money available for them to be paid and make purchases.

I thought the root of deflation is prices are too high, not necessarily that there is not enough money? These may sound like the same thing but I think there are enough subtle differences which can lead to things like a liquidity trap. As I mentioned earlier, perhaps the problem isn't monetary but structural. If there is a liquidity trap then that means that monetary policy has been exhausted and it is unwise to ramp up the printing of money.

 

[Narmer]

This is incorrect, deflation caused by increased efficiency and the lowering cost of production increases wages and creates jobs.

We are looking at things from different sides of the same coin.

 

[Narmer]

This is not deflation, but a lowering of the actual price.

Think of price in terms of opportunity costs. I make enough money to buy 1 apple. If the price goes down, for the same amount of work, I can buy 2 apples. However, if there is deflation, the amount of money I spend on an apple goes down, but my wages also went down, so I still only make enough to buy 1 apple.

Deflation is when the number of dollars changes, but you still get the same amount of stuff, lower prices is when you can get more stuff for the same amount of work.

Deflation makes your money more valuable, not less. Also, the marginal rate of change between wages and prices are not necessarily constant. In fact, I would say that prices change much much faster. The real danger is not the person in his current job but the individual who has lost his job or the college graduate entering the workforce. Their wage is much lower than at a similar stage for the current worker. This provides a disincentive for them to spend.

 

[daishi5]

Deflation makes your money more valuable, not less. Also, the marginal rate of change between wages and prices are not necessarily constant. In fact, I would say that prices change much much faster. The real danger is not the person in his current job but the individual who has lost his job or the college graduate entering the workforce. Their wage is much lower than at a similar stage for the current worker. This provides a disincentive for them to spend.

Deflation makes money more valuable, but not your work. Increases in efficiency make your work more valuable. If prices change, wages have to change, because the price paid for goods is the source of the revenue used to pay wages.

 

[Mark R]

I have a terribly misinformed question:

Why can't deflation be combated by printing more money? Can inflation be used in this manner?

Printing money can be used to counteract deflation. It was used in Japan, after they dropped interest rates to 0. However, it didn't really solve the problem, as deflation remained for over a decade (it's been argued that the BoJ didn't print enough).

It's been used in the UK when the Bank of England printed £200 billion in 2008-2009, after the economy continued to crumble despite interest rates being cut to virtually 0. This amount of printing was unprecedented (and when corrected for the size of the economy, this was something like 5x the amount that Japan printed).

The Federal Reserve bank has also been printing $, but on a smaller level.

The problem with printing, is what you actually do with the money. In all these 3 cases, the money was used to buy government bonds. These are mainly owned by commercial banks (as an ultra-safe investment, and an alternative to stocks or other more risky investments). The idea is that if the central bank can buy all the ultra-safe investments up with printed cash, banks and other investors will have no choice but to spend the cash on making risky investments (e.g. loans to small businesses, mortgage lending, business ventures, etc.)

In fact, what we saw in the UK, was that quite a lot of this newly printed money *didn't* get invested into risky investments. The investors (mainly commercial banks) just hoarded the cash, and accepted that they were getting 0 interest for it as the price of having guaranteed safety (but hey, making 0% isn't too bad when interest rates are almost zero).

This is the same problem that you get with just lowering interest rates to 0. It's known as a 'liquidity trap' - once investors are scared off from risk, it's very difficult to entice them back. And unless you get investors wanting to buy stocks, houses, commercial real estate, or invest in new businesses (that would need new buildings, computers, trucks, etc.) then you end up with reduced demand, falling prices and deflation.

There is also risk with printing money, that it could stimulate inflation. One of the problems when a liquidity trap occurs, is that huge pools of idle cash build up in the economy - and if conditions turn, then you can get a very quick, and overheated recovery - causing a spike of, potentially very severe, inflation. This is theoretical, and we haven't seen it happen in any country that has used printing in a controlled way.

 

[CLite]

We are looking at things from different sides of the same coin.

In one case the economy is roaring ahead due to better efficiencies. In the other case the economy is strangled by a limited money supply.

Saying both cases of deflation equate to decreased wages and job loss is incorrect. This isn't something that could be left up to a matter of opinion.

 

[Narmer]

In one case the economy is roaring ahead due to better efficiencies. In the other case the economy is strangled by a limited money supply.

Saying both cases of deflation equate to decreased wages and job loss is incorrect. This isn't something that could be left up to a matter of opinion.

So if I invent a machine and algorithm software that makes all cable technicians redundant and increases efficiency of the cable system and makes customers happy, there isn't a negative effect on the larger economy with all these unemployed technicians? If you have a decrease cost that is passed on to the consumer (as with almost all modern technology) and an increase in the unemployment rate, isn't less money being spent in the economy? Of course, these technicians, most of whom never graduated from college and used to be paid between $50k-$100k, will have to either return to school (unlikely) or take on jobs that pays of fraction of what they made, competing with teenagers. All this has a knock-on effect on the economy.

 

[CLite]

So if I invent a machine and algorithm software that makes all cable technicians redundant and increases efficiency of the cable system and makes customers happy, there isn't a negative effect on the larger economy with all these unemployed technicians? If you have a decrease cost that is passed on to the consumer (as with almost all modern technology) and an increase in the unemployment rate, isn't less money being spent in the economy? Of course, these technicians, most of whom never graduated from college and used to be paid between $50k-$100k, will have to either return to school (unlikely) or take on jobs that pays of fraction of what they made, competing with teenagers. All this has a knock-on effect on the economy.

This decreases the cost of the service to consumers which increases the number of consumers that can have it and allows the consumers to spend money on other items, potentially to hire more employees. Additionally the creator of this product will have a surplus of income that he can use to expand the business in alternative ways which also leads to people being hired.

This is INCREDIBLE for the economy.

Alternative side = no one has money to buy the service; therefore the provider has to lower the cost to get people to buy it. Effectively the number of people that can buy the service decreases, the person has to fire a bunch of people and the consumers are still spending the same proportion (if not more) of their budget on this service. This restricts them from expanding in alternative directions as well.

This is TERRIBLE for the economy.

See the obvious dichotomy?

 

[Narmer]

This decreases the cost of the service to consumers which increases the number of consumers that can have it and allows the consumers to spend money on other items, potentially to hire more employees. Additionally the creator of this product will have a surplus of income that he can use to expand the business in alternative ways which also leads to people being hired.

This is INCREDIBLE for the economy.

Alternative side = no one has money to buy the service; therefore the provider has to lower the cost to get people to buy it. Effectively the number of people that can buy the service decreases, the person has to fire a bunch of people and the consumers are still spending the same proportion (if not more) of their budget on this service. This restricts them from expanding in alternative directions as well.

This is TERRIBLE for the economy.

See the obvious dichotomy?

I think you missed one of my points in the example I gave. If all these technicians are fired, then money is concentrated into far fewer hands because it now takes less to do more at the company. This benefits far fewer people. Of course, these richer individuals can invest the money into something else, possibly starting a new business, however, the money is in the equivalent of a deep well as opposed to a shallow lake. The richer individuals will spend relatively less of that money in less places compared to it being in the hands of all those technicians. Of course, new found wealth for the consumers means they can spend theirs elsewhere in the economy. However, the majority of the wealth created will be in the hands of the few rather than the many. Worse, the newly unemployed will have to start over, career-wise, which can have an effect on the entire economy.

My point was to show that deflation means that a price correction is necessary. This may mean a new state of the economy where overall prices are lowered and the type of worker changes. This is literally reforming the economy to adjust it to new technology and prices.

 

[zephyrprime]

You can qualify it but that does not change the fact that it is still deflation. We must admit that deflation, no matter what it's called, lowers wages and kills jobs. As with everything in life, there will be winners and losers.

Deflation through technological advance (like automation) increases wages and has no effect on jobs.

Why do you think we have more material stuff now that we did 300 hundred years ago? It is simply because we have machines, electricity, the knowledge about chemicals, and etc. And yet, all of these advancements displaced workers. However, freeing up labor while increasing production by a quantity greater than the amount of production freed up by laying off the worker enables increases in real wealth.

We have huge increases in automation now versus 300 years ago. If automation kills jobs, why do we not have 99% unemployment now? Automation DOES kill jobs in the local context. Within the broader context of the entire economy, automation indirectly enables new jobs to be created in equal number to the number that were destroyed.

It seems like the US is losing jobs and wages are deflating due to automation and outsourcing. This is true for the US. However, for the economy of the world as a whole, this is not true. If you add in all the jobs that are created in India and the wage increases there, you will see that the net aggregate job growth is just about zero and the real total wages in higher.

 

[QuantumPion]

Ah a classic misconception that we should focus on. There is good deflation and there is bad deflation.

Good deflation is the increase in supply of products due to efficiency which lowers their price. This increases the "wealth" of a nation.

Bad deflation is the decrease in supply of money versus demand. This is the deflation we talk about when referencing the great depression, and it is what everyone fears.

This isn't quite right. When an industry produces goods more efficiently and cheaply, that is not deflation. That is productivity increase.

Deflation is when the cost of EVERYTHING in the entire economy decreases simultaneously. Same goes for inflation.

 

[CLite]

This isn't quite right. When an industry produces goods more efficiently and cheaply, that is not deflation. That is productivity increase.

Deflation is when the cost of EVERYTHING in the entire economy decreases simultaneously. Same goes for inflation.

Incorrect,

http://www.forbes.com/forbes/2002/0218/112.html

Instead, look for the good deflation of excess supply driven by new tech. This was true in the late 1800s, when the Industrial Revolution and railroads created tremendous productivity and excess capacity. The economy grew an extraordinary 4% per year in real terms between 1870 and 1896, as wholesale prices fell 50%. Similarly, the Roaring Twenties were deflationary, as electricity and autos spread. Another boom occurred.

There is good deflation and bad deflation.

*edit* more precisely there is supply-side deflation and demand-side deflation. Productivity increase inheritely reinforces supply-side deflation. Sometimes on the whole economy ala 1800's or sometimes in small parts of the economy ala the exceptional drop in computer prices over the last couple decades. Either way it's a deflationary change.

 

[Narmer]

Deflation through technological advance (like automation) increases wages and has no effect on jobs.

Why do you think we have more material stuff now that we did 300 hundred years ago? It is simply because we have machines, electricity, the knowledge about chemicals, and etc. And yet, all of these advancements displaced workers. However, freeing up labor while increasing production by a quantity greater than the amount of production freed up by laying off the worker enables increases in real wealth.

We have huge increases in automation now versus 300 years ago. If automation kills jobs, why do we not have 99% unemployment now? Automation DOES kill jobs in the local context. Within the broader context of the entire economy, automation indirectly enables new jobs to be created in equal number to the number that were destroyed.

It seems like the US is losing jobs and wages are deflating due to automation and outsourcing. This is true for the US. However, for the economy of the world as a whole, this is not true. If you add in all the jobs that are created in India and the wage increases there, you will see that the net aggregate job growth is just about zero and the real total wages in higher.

We do not have 99% unemployment because we reformed the economy through higher education. Also, with regarding to us decreasing and india increasing, this is a balancing act of the two worlds. In open economies, this is inevitable.

 

[Narmer]

Incorrect,

http://www.forbes.com/forbes/2002/0218/112.html



There is good deflation and bad deflation.

*edit* more precisely there is supply-side deflation and demand-side deflation. Productivity increase inheritely reinforces supply-side deflation. Sometimes on the whole economy ala 1800's or sometimes in small parts of the economy ala the exceptional drop in computer prices over the last couple decades. Either way it's a deflationary change.

I think there is a relationship between the two but I'm not exactly sure where the link is but I'll take a guess. Let's divide an individual. One part is the consumer and the other part is the laborer. If the consumer gains at the expense of the laborer, then you have a dichotomy that can only be resolved by reforming the economy. In Japan, because of high prices, most Japanese companies took production to China and elsewhere. Hence, while the consumer benefits, the laborer loses badly. In a relatively closed economy, both sides benefit. But in an open economy, the benefit is realized elsewhere. Even though technology is helping all, perhaps this is why the Japanese feel that their living standards is decreasing while those in developing countries feel the opposite.

 

[CLite]

I think there is a relationship between the two but I'm not exactly sure where the link is but I'll take a guess. Let's divide an individual. One part is the consumer and the other part is the laborer. If the consumer gains at the expense of the laborer, then you have a dichotomy that can only be resolved by reforming the economy. In Japan, because of high prices, most Japanese companies took production to China and elsewhere. Hence, while the consumer benefits, the laborer loses badly. In a relatively closed economy, both sides benefit. But in an open economy, the benefit is realized elsewhere. Even though technology is helping all, perhaps this is why the Japanese feel that their living standards is decreasing while those in developing countries feel the opposite.

Well I suppose you can say the overall supply-side deflation the world is experiencing by labor arbitrage can result in some micro-parts of the global economy to undergo a demand-side deflation.

For instance in the 1800's the purchasing power of some manual labor folks potentially decreased, but the huge ramp up in productivity and efficiency generally expanded the U.S. purchasing power.

Currently, you could argue that if labor arbitrage is carried out to the fullest extent that the purchasing power of the world will increase but the U.S. could decline. This kind of scenario is why I believe we need to re-industrialize America and dedicate ourselves to a new era of technological development, to preserve our relative economic power.

 

[soulcougher73]

On a related note, I don't see what the purpose is of inflating long-term wages and prices at the same rate. That is, one dollar might have had more purchasing power 50 years ago, but people also made correspondingly less. If prices and wages continue to rise at 3%/year on average, what is really changing? Why not keep both of them constant?

I suppose you could debate whether long-term wages have kept pace with inflation, but that might be going too far off topic.

Im no econmist but i have always wondered that as well. If everything goes up roughly the same percent what is the point other then a larger $ figure?

 

[Narmer]

Well I suppose you can say the overall supply-side deflation the world is experiencing by labor arbitrage can result in some micro-parts of the global economy to undergo a demand-side deflation.

For instance in the 1800's the purchasing power of some manual labor folks potentially decreased, but the huge ramp up in productivity and efficiency generally expanded the U.S. purchasing power.

Currently, you could argue that if labor arbitrage is carried out to the fullest extent that the purchasing power of the world will increase but the U.S. could decline. This kind of scenario is why I believe we need to re-industrialize America and dedicate ourselves to a new era of technological development, to preserve our relative economic power.

I agree to an extent. As other nations realize their full power, our relative power will inevitably decline. However, if everyone plays fair, we all win.

 

[daishi5]

Im no econmist but i have always wondered that as well. If everything goes up roughly the same percent what is the point other then a larger $ figure?

The real goal is to inflate the amount of money at the same rate as the increase of population and productivity which would cause no inflation or deflation. But, it is hard to measure them, and if we are too slow it can cause huge problems. So they aim for a small amount of inflation, that way if they get too little they just experience less inflation then intended, instead of deflation, and the issues related to it.

 

[Narmer]

The real goal is to inflate the amount of money at the same rate as the increase of population and productivity which would cause no inflation or deflation. But, it is hard to measure them, and if we are too slow it can cause huge problems. So they aim for a small amount of inflation, that way if they get too little they just experience less inflation then intended, instead of deflation, and the issues related to it.

Source? I'm not doubting you but I would like to understand the origin of the target inflation.

 

[daishi5]

Source? I'm not doubting you but I would like to understand the origin of the target inflation.

I will need to look through a few of my books, I know I have a couple that discuss it.

 

[Special K]

The two extremes (Strong inflation and just about any deflation) are both serious problems. So, you are right to avoid them both. But, I don't think the proper balance point is right at 0%. There are many reasons.

1) 0% is right near the deflation zone, 0% is a very unstable location. A slight dip in that direction can take us to a far worse condition (deflation spiral).

This makes sense.

2) Slight inflation doesn't cause much of any harm.

I guess not. I still don't like my money losing value over time though.

3) People want raises. In order to give raises, a business needs to bring in more money (ie raise prices). All of their supplier's employees want raises, so they raise their prices. Heck, even the shareholders want bigger and better returns, and so businesses raise prices. You can't have raises without inflation. And if we just keep wages at 0% growth, that gives very little motivation to work hard. No hard work means poor productivity, and we spiral into a recession/depression.

Here I would distinguish between a COLA and an actual raise. A COLA will just keep pace with inflation, whereas a raise is supposed to increase your income above and beyond inflation. Because raises should be merit-based, not everyone can get one at any given company. COLA's would be unnecessary if inflation were at 0%. A raise of 3% would effectively increase your purchasing power in that case, whereas now it will basically offset the effects of inflation.

4) Psychology. People buy now because prices will be higher later. If people buy now, we can hire people now. So people now have more money to buy now. This is a strong positive upward spiral. Everyone gets better. But that all ends when you take away the incentive to buy now.

On some level I agree with this, but it seems this mentality is what gets people into trouble when recessions hit. They lose their jobs or have an emergency and have little or no savings to fall back on. If people are encouraged to spend every dollar they make because it will lose value if they don't, then it seems like that is encouraging irresponsibility. Obviously you can always choose to save your money anyway, but I personally hate the fact that my emergency fund is going to constantly lose value over time because I choose to put it somewhere safe and not spend it.

5) It isn't just about wages vs prices. There are other main factors such as loans. People are willing to have loans because they know that they'll make more money later to pay them off. Borrow now when money is dear, and pay it off later when you have plenty of money. You can't take away the wage/price issue and think that the remaining contracts will be fine. People have loans for 30+ years. Businesses have contracts sometimes for 100 years. These loans/contracts were all signed with the assumption of a reasonable inflation rate. Fixing wages/prices to 0% is a massive money shift from one party in the contract to the other party. We'd have to go and renegotiate all long-term contracts in order to do this even remotely fairly.

Interest rates on loans are set based on inflation expectations, right? If inflation were 0%, it seems the interest rates on loans would just be lower since the lender would need to charge less in order to turn a profit.

Overall I think the best argument for slight inflation is that 0% is too difficult a target to maintain, and the consequences for going negative, i.e. deflation, are far more severe than the consequences for going over 0%.

 

[sandorski]

The problem as I see it is that things cannot continue to grow forever. There are simply a limited amount of resources on this planet, and this ever-expanding view cannot last forever.

True, but what that means is that we need to get our ass to Mars.