Posted on 11/30/2008 10:49:54 AM PST by Captain Kirk
“Why would you or a business buy something today when it’s just going to get cheaper in the future?”
If something is cheaper today, that does not mean it will be cheaper in the future. It could be cheaper, or the price might remain the same, or the price could bounce back up. One has more certainty about today’s price (cheaper) than about the price in the future. Also, one can buy today, and buy again in the near future. One could stock up in anticipation of future price increases.
Also, when prices have fallen, there is little reason to conserve.
“Well, that was quite the response. Possibly the biggest I’ve ever seen to one of my posts. So.....it appears that the upshot is that you don’t consider deflation a threat if wages are allowed to adjust to the new price baseline. Correct?”
LOL! Didn’t mean to run on so...dull Sunday afternoon and all that.
In answer to your question...
...correct. Deflation need not cause unemployment if wages are not forced above the market level. Deflation need not cause market gluts of products that “won’t move” if prices are flexible and there are no artifical price supports keeping them high.
Ted Allrich:
“As prices decline, businesses sell less”.
Perhaps it is:
As businesses sell less, they lower their prices.
Allrich has his causation bass akwards. He has put the cart before the horse.
Good analysis. But please note that you provided definitions from the Austrian school of economics. It is more standard to refer to an increasing price level as inflation. I think there must be some way for modern “Austrians” to use standard definitions for inflation and deflation and still get their point across.
But the Fed and treasury are now printing real dollars and sending them out into the money supply. So it seems to me that we are replacing some real wealth lost, but also a lot of paper losses, with a real increase in the money supply.
In that case, it probably wouldn’t be inflationary. But money that is there just to make the balance sheets look good would just create zombie banks like in Japan.
He sounds like he's merely repeating something he heard (on MSNBC?).
True, which explains why inflation with the deflation that follows, induced by government policy distorts markets.
There would be resistance to anything to lower credit card interest rates because is is unsecured debt, but in this environment where even secured debt is underwater and illiquid, there's actually not much risk difference between secured and unsecured, if the borrower at least has good credit. Most people who have credit card debt have good credit and are not going to go bankrupt or default on the credit cards, but they will not be spending until their debts are paid down. By lowering the interest rates, we can accelerate paying down those debts, and will accelerate the uptick in the consumer spending which will bring us out of the recession.
I am not calling for the govermnent to do this, but regular banks.
No, the issue with deflation is that if companies won’t be able to sell the products at the cost it took to make them, they’ll have to stop producing. Because companies must buy their inputs before selling their outputs, that is what happens in a deflationary environment.
And, of course, a drop in prices for selected goods is not the same as a general deflation.
In a deflationary environment history has shown us that consumers, and especially businesses, don't make the capital investments they would in a non-deflationary environment.
History has also taught us that during periods of deflation businesses slow production and increase layoffs. Removing those jobs from the economy further weakens demand for many products and services. Incomes also decline during periods of deflation. All of this causes businesses to sell less when deflation is occurring, which is exactly what the author claimed.
It could be cheaper, or the price might remain the same, or the price could bounce back up.
Ok. But that doesn't detract from the fact that consumers and businesses spend and invest less during periods of deflation.
One has more certainty about today’s price (cheaper) than about the price in the future.
Maybe you should look at Japan in the 90's. They went through almost a decade of deflation. Throughout the 1990s, prices for property and other goods kept falling thereby eliminating incentives for companies to invest. As job losses increased purchasing power declined, goods piled up and that sent prices even lower. It took years for them to stop that downward spiral.
Falling prices reduce opportunities for profit and make companies reluctant to invest even when the government lowers interest rates to zero.
That said, I don't believe we're in a deflationary environment. October's producer price index is up more than 5% over last year's numbers and is up 4.6% with food and energy removed. Over prior year, consumer prices are up 3.7%. Ex-food and energy, prices are up 2.2% over prior year.
It's funny what some here see as deflation.
“It is more standard to refer to an increasing price level as inflation. I think there must be some way for modern “Austrians” to use standard definitions for inflation and deflation and still get their point across.”
Well, the analysis was certainly in the Austrian tradition. The definitions? I think the idea of “inflation” relating directly to an increase in the supply of money, and only indirectly to a general rise in prices (ceteris paribus) which is caused by that increase, is common to the Chicago school, as well, and possibly even to others.
Personally, I think the more important distinction is between the ideas of “nominal” and “real.” “Nominal” wages, for example, represent the printed amount on a worker’s paycheck. “Real” wages, however, represent the purchasing power of that paycheck. This is neither Austrial nor Chicago, but just plain “classicial”, having been recognized by Smith, Ricardo, Mill, Say, etc.
“Real” wealth vs. “nominal” wealth, e.g., strikes at the heart of whether or not a measurement such as “GDP” is meaningful. Peter Schiff understood the issue, I thnink, better than Arthur Laffer when he told him that the rise in GDP (from 2006, I believe) was not REAL wealth; it was just inflated nominal wealth — paper money wealth. Laffer reacted by saying something like “That’s STILL wealth!” Tell that to the citizen of Berlin during the hyperinflation after WWI. Was he wealthy when he needed a wheelbarrow full of paper currency to buy a loaf of bread?
Anyway, not trying to be a purist here. For me, the important thing is to get the ideas out in a form that people can understand. I think a writer like Henry Hazlitt was excellent (and on television, so was Milton Friedman). I would like the “oridinary Joe” to understand the following:
The free market represents a tightly coordinated “harmony of interests” of its participants. There is no anarchy in a free market. The tight coordination is accomplished by the social miracles of division of labor and prices. Any interference, therefore, with division of labor or prices will interfere with the harmony of interests of those in the market (which is pretty much everyone who chooses to live in society, as opposed to living self-sufficiently on a desert island). Contrary to received opinion, government regulations interfere with division of labor and prices; the purpose of government regulation can only be to attempt to help one group of market participants at the expense of EVERYONE ELSE. Not only is this inherently unfair, but there is always economic “blowback” from regulation: unintended negative consequences that were not foreseen and which are considered negatives even from the point of view of those advocating the original regulation. Thus, either the original regulation must be revoked, or yet more regulation must be enacted to deal with the problems from the first regulation. The tendency will be to continue to regulate ALL areas of the economy, at which point all around economic planning will ensue. This, of course, is simply tyranny — Hayek’s “Road to Serfdom.”
I thought that Friedman made a pretty good case for these arguments in his old PBS series “Free to Choose,” but maybe something more contemporary needs to be done.
Always interested in ideas and suggestions...
I think one problem is to start with deflation (a falling price level) and ignore its causes. Many of the anti-deflation talk ignores the underlying cause. For example if consumer demand falls, there will be less demand for goods and services, and employment will fall. Oh yes, prices will fall too. But the falling prices are not the cause of the low employment. If anything, they are a self-correcting tonic.
We had reduced demand during the Depression and reduced jobs. Prices started to fall and this could have revived demand. FDR went on a campaign to keep wages and prices high, and this extend the depression. UCLA economists recently concluded that his price maintenance policies extended the Depression 7 years.
From the Higgs article:
“To elaborate just a bit, the rate of economic growth from 1866 to 1897, a period of secular deflation, was perhaps the greatest ever experienced by the U.S. economy during a period of comparable length. Real GDP grew by more than 4 percent per year, on average, notwithstanding the persistent deflation.”
My preference would be for a constant price level. Then again, I wouldn’t have the press talk down the economy for political purposes, or have the nation elect a party of job killers. After these problems, prices may react - perhaps rationally.
With the government printing billions and trillions of dollars, your money is worth less. By printing all of this worthless money those $150,000 homes that people bought for an inflated price of $300,000 will now be worth $300,000. In other words we are not helping families who were stupid enough to get themselves in that position, we (the tax payers) are helping the banks and lending institutions who were stupid enough to make bad loans. This will cover the asses of the politicians who urged that banks to make the bad loans. You, the honest tax payer, who lived within his/her means will now have to pay for all of this like it was your fault.
And if you are considering it as place to live rather than an investment ... it's still a place to live and everything's ok.
That graphic is terrifying.
$50 Trillion in Global Wealth Gone in 1 Year: Examining the Financial Markets of the World.
Thanks for the excellent post. The Robert Higgs article is very good too. I agree with all of your post with merely some difference on the term deflation.
I was taught that inflation was an increase in the general price level, and deflation a fall in the general price level. That was drummed into me more than once. The origin of a change in the general price level could be monetary (change in the money supply), or something else. I think this is Robert Higgs’ understanding also. For what it’s worth, that is the fist meaning given by Wikipedia (see Post 29). Their second definition seems to capture your usage.
I guess I will have to be alert to the distinction. For example, I can write “deflation (fall in the general price level).” Others might write “deflation (decrease in the money and credit).” This seems awkward, but may be best.
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