Why is deflation bad?

Discussion in 'Economics' started by noob_trad3r, Aug 2, 2010.

  1. http://online.wsj.com/article/SB100....html?mod=WSJ_hpp_MIDDLENexttoWhatsNewsSecond

    Shouldn't deflation be a good thing, a natural correction in prices that were too high to begin with? How does it make sense to have an inflation only policy?

    Since the US is entering an era of low wage service McJobs why is it wrong for the cost of living and housing to go down accordingly to meet wages?

    But I have yet to experience this deflation.
  2. pspr


    Mainly, purchases are put off waiting for lower prices causing the economy to go into the tank. Also, using debt to expand business or buy anything becomes unfeasible so growth slows significantly and the government can do little to get out of deflation.
  3. That's like asking why was the Great Depression bad? Since it was deflationary.
  4. The problem we have had is Credit inflation, too much credit to make up for lack of wage growth.

    Now that Credit is shrinking so should prices.

    Also the Great depression was caused by a big credit bubble just like now.

    But the good news compared to what happened in the great depression is we do not have an industrial core that will sit idle, all of that is in china/india/philippines/mexico.
  5. empee


    The arguement against deflation is largely a political one. Inflationary biases make dumb people rich via economic imbalances, and they want to stay that way. Since its "imbalanced", eventually deflation sets in and thus is considered "bad" since it punishes those who have won during the inflationary cycle in an unfair way.

    While the short-term effects of deflation can be bad, overall its the working class that wins. How? During inflationary phases workers salaries go up, but not as fast as inflation (thus net losers), while financiers leverage money to get a better return than inflation. In addition, the wealthy and banks benefit the most because they have the first access to the money at the lowest interest. For example, if you had a low risk investment that returned 2% but you could only borrow money at 3%, you couldn't take the trade. Banks can borrow at .25% today.

    Eventually, asset prices go so far out of whack with reality (because ultimately the way to justify higher assets prices is assuming they are recovering only interest on the debt because "it always goes up") that the cycle breaks (ie the working class who's income supports the assets prices can't support the asset prices any longer). During the cycle another pernicious effect has happened, the financiers have also created jobs who are solely dependent on this cycle, so these jobs are destroyed as well.

    The on-come of deflation is the expected outcome since asset prices eventually have to return to what can be supported by the actual working class's income. During the inflationary phase asset prices and thus the cost of living go up faster than the working classes, so although the working class is making more, inflation adjusted its making less. Meanwhile, the financier is unbelievable sums by leverage and asset inflation (ie far greater than inflation).

    The opposite occurs in deflation, the financer is wiped out (unless bailed out by the govt) and the working classes incomes fall, but the cost of living falls FAR more. Ie the working class gets off the treadmill of 3% inflation and 2% income growth and can't figure out why they can't save or have enough for retirement.

    During this phase all the jobs related to the inflationary phase go away because there is no real purpose for those jobs in the first place.

    This is how societies commit suicide, you have a large part of your populace trained for useless jobs (mortgage broker, etc). so they are effectively destroyed (no one wants to hire these people and have to retrain them when they are going to make 30% of what they made before when you can hire a younger worker without the chip on his shoulder.. thus these workers are effectively lost).

    During the bust, women largely replace working class males because they are cheaper to do many of the same jobs. Women don't want to marry unemployed men, so they don't reproduce.

    Anyway, I believe if we had deflation the working class would be better off, remember the financier's income goes from stratospheric levesl to ZERO if asset prices don't go up (regardless of how far below inflation he can source the money from the govt).

    Why does the working class vote for these policies? Because it allow politicians to offer them a free lunch, "rising" (not inflation adjusted) incomes and benefits without having the pay for them.

    During the 2003-2007 period, the top 1% income earners income went up something like 38%. Thats largely asset based, especially since in 2008 it dropped 22% (while working class fell around 5-6%)

    But who is going to vote for a politican that doesn't promise something or nothing? No one, thats who.
  6. The main problem is the cost of debt repayment. The real cost of repayment of loans increases. This is not good when you have large deficits aka now.
  7. The only way to inflate will require pure QE via Actual stimulus checks to people, not infusions of cash into banks which just end up going into treasuries getting risk free interest from free money.
  8. I never said inflation was good just that that is the reason deflation is bad. In any event I agree with you QE is not good especially the way they did it. The are some other options. Velocity of money is one.

  9. Yes, thats why the US govt should mail a cheque of 10k to every person in the USA. I also need to pay my rent.
  10. Maybe but that doesn't help the output. You would be better advising them to create employment through government schemes. The downside to that is that they are often not efficient.
    #10     Aug 2, 2010