Nonsense About Deflation

Liberty and Power at the History News Network ^ | November 30, 2008 | Robert Higgs

[ChessExpert]

“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.”

I’m not advocating deflation (a fall in the general price level). Nor do I advocate inflation. By the way, unanticipated changes in the price level have an impact that is greater than if the change were anticipated. For example, back in the 70’s and early 80’s everyone expected inflation and many protected themselves, at least partially.

Is unanticipated deflation a good thing? Generally not. But if you think it’s rough selling goods for less than the cost of production, consider not selling goods at all. As you point out, the costs have been born already. Do you get some money back, or none at all?

[GoodDay]

Hi, thanks for the reply.

I think the way it’s sometimes put (without making the finely drawn distinctions in Austrian usage) is to speak of “PRICE inflation” vs. “MONETARY inflation.” The first is a rise in the aggregate price level regardless of cause; the second is an increase in the quantity of money and credit regardless of effect.

[9YearLurker]

You’re right, if you’ve already sunk the cost of the product, it’s better to recoup what you can by selling it. The problem with deflation is when it is anticipated, because that’s when businesses stop producing—because they won’t buy inputs they expect to lose money on. It is fundamentally different than inflation, in which as you point out companies can plan ahead and still produce.

[Mase]

I can't speak to what happened from 1866 - 1897. However, I do believe Milton Friedman when he tells us that inflation is always and everywhere a monetary phenomenon. Conversely, deflation will be defined as a decrease in the money supply.

We can debate the definition of money but I think Friedman won the debate over the root cause of inflation and deflation long ago.

The author stated that during periods of deflation businesses sell less. Another poster called that statement ignorant. My purpose for responding was to show that the author is accurate given the current global financial system. I can't think of one country using a gold standard today.

[Mase]

My anecdote is meaningful in that it disproves the author's "As prices decline, businesses sell less" nonsense.

Sorry, your anecdote is simply an anecdote. First of all, we're not in a period of deflation. Second, if we were experiencing deflation a one or two day measure of consumer spending is far too narrow to draw any such broad conclusions.

Perhaps, but that's not what I was commenting on.

Then I don't know what your point is. Businesses sell less in a deflationary environment for the reasons I offered.

But the comment that was ignorant and remains so is the sweeping: ""As prices decline, businesses sell less".

The author was referring to a general decline in prices, which is a definition of deflation, even if he wasn't explicit in his communication. Maybe he believed the reader would understand this to be the case given that the article was about deflation.

[ChessExpert]

“I can’t speak to what happened from 1866 - 1897.”

The Higgs article is worth reading. I believe Friedman covers this period in his book “Money Mischief,” and probably in a more readable way in other books.

“However, I do believe Milton Friedman when he tells us that inflation is always and everywhere a monetary phenomenon.”

Friedman was countering the prevailing Keneysian orthodoxy which addressed aggregate demand only and ignored money. Could natural, or man made, calamity affect prices also? I think so, and I think he would agree. I don’t think his words should be cast in stone. I don’t think he would do so himself.

“Conversely, deflation will be defined as a decrease in the money supply.”

That is a minority definition. The dominant definition is a general decline in prices. Wikipedia covers this well.

“We can debate the definition of money but I think Friedman won the debate over the root cause of inflation and deflation long ago.”

I don’t think he would rule out the idea war, a regulatory recession, war, natural calamities and other non-monetary events that could affect prices. Too bad he isn’t around to address the current financial mess. I think he always tried to address the most important issue of the day, using the most important consideration of the day. There is more going on in our current financial mess than a change in the monetary base. Speaking of the monetary base, please see post 52.

“The author stated that during periods of deflation businesses sell less. Another poster called that statement ignorant.”

Which author?

There are two authors and they hold opposite views. Robert Higgs, the author of the article, disagreed with Ted Allrich, the author of the quote. I recommend reading the entire article.

“My purpose for responding was to show that the author is accurate given the current global financial system.”

I give higher accuracy ratings to author Higgs than to author Allrich.

“I can’t think of one country using a gold standard today.”

A gold standard might be a good idea as it reduces government’s power to act irresponsibly. However, governments would still have great latitude to act irresponsibly.

[JPJones]

The author was referring to a general decline in prices, which is a definition of deflation, even if he wasn't explicit in his communication. Maybe he believed the reader would understand this to be the case given that the article was about deflation.

There can be very distinct difference between declining prices and deflation:

As China ramps up production, the prices of plastic toys in America declines. Is that deflation?

As loans dry up, the prices of housing declines. Is that deflation?

[Mase]

As China ramps up production, the prices of plastic toys in America declines. Is that deflation?

Deflation in the price of toys? Yes. A general decline in prices? No.

As loans dry up, the prices of housing declines. Is that deflation?

Deflation in housing as an asset class? Yes. A general decline in prices? No.

[JPJones]

Deflation in the price of toys? Yes.

And what happens when the price of toys declines?

We buy more.

[Mase]

The author wasn't referring to deflation in a particular product or service. He was talking about a general decline in prices. Think big picture. Not just cars. Not just toys. Not just houses.

Besides, during a recession, prices of toys may fall (deflation in a particular product category) but we will purchase less of them. Detroit could lower the price of their cars now but we'd still buy less of them.

[JPJones]

Besides, during a recession, prices of toys may fall (deflation in a particular product category) but we will purchase less of them.

Perhaps, but it's more likely prices would rise during a recession. Conversely, during a period of "general decline in prices" some businesses (like McDonalds,) will sell more.

[Mase]

No. Pricing power is significantly diminished (as are margins) during recessions. If prices happen to increase with certain products or services during a recession it’s due to the existence of inflation or the unique attributes of a product or service that have increased the demand.

[JPJones]

No. Pricing power is significantly diminished (as are margins) during recessions.

The whole 1970's disproves that statement. It was a recession where general prices rose dramatically.

[Mase]

You need to read my full comment again. I said that this is true unless we have a recession with inflation (thus the term stagflation) like we did in the 70's. That was a unique event. Had you run a business, pretty much any business, during the years we suffered from stagflation you'd know that sales, margins and profits were very hard to come by. We weren't buying more.

I'd also suggest that you take a peak at the front page of yesterday's WSJ Marketplace section where an article clearly explains why retail sales are in the dumper even though massive discounting is occurring. Retailers are experiencing the worst YOY growth since at least 2002.

How can this be when we buy more when prices are declining?

[JPJones]

You need to read my full comment again. I said that this is true unless we have a recession with inflation (thus the term stagflation) like we did in the 70's. That was a unique event. Had you run a business, pretty much any business, during the years we suffered from stagflation you'd know that sales, margins and profits were very hard to come by.

We weren't buying more.

Correct, prices were rising and we (businesses) weren't buying more.

Retailers are experiencing the worst YOY growth since at least 2002. How can this be when we buy more when prices are declining?

Because it's not altogether true, some retailers are having record gains:

NEW YORK (CNNMoney.com) -- Wal-Mart Stores reported November sales that trounced expectations Thursday as the discounter continues to gain market share from its rivals in a worsening economy..... ....Additionally, the company said its aggressive holiday discounts also drove "record grocery sales" in November and lifted sales in the home, clothing and electronics categories.

http://money.cnn.com/2008/12/04/news/economy/Nov_retailsales/index.htm

Besides big gains at Walmart there's BJ's and Big Lots posting gains.

Those retailers not doing well, should lower there prices more.

This thread is getting silly with semantics. It's simple: Prices go up people eventually buy less. Same when prices go down, with the caveat: different products different elasticity.

The original quote "prices decline businesses sell less" is putting the cart before the horse, even in a deflation enviroment.

What he really meant to say for this current situation:

" money (credit/liquidity) dries up, businesses sell less".

And for that brilliant piece of insight this idiot gets published.

[Shigarian]

The anti-deflation zealots ignore utility.

Even though the computer I'm about to buy can probably be had for 10% less (or a computer 10% more powerful for the same price) a year from now, I'm not about to put off buying it just so I can get something better in the future. The cost of denying myself the use of a computer for a year outweighs the small gain that would come from holding on to my cash.

I suspect that what they really mean is that people would stop over-spending, parting with more cash than they'd like to because they know that the cash will be worth less under government-sponsored inflation, and so they might as well get something for it now.

[Mase]

Correct, prices were rising and we (businesses) weren't buying more.

Consumers and businesses weren't buying more because of the recession. Consumers and businesses will also buy less during periods of deflation.

Because it's not altogether true, some retailers are having record gains:

Besides big gains at Walmart there's BJ's and Big Lots posting gains.

Some businesses increase sales during recessions and during deflation. So what? That's nothing new. We're (and the author) looking at the macro view, not the micro.

Those retailers not doing well, should lower there prices more.

If you'd read the article from the WSJ you'd now know that retailers across the board are massively discounting their prices, and although this is bringing more buyers into the stores than they had before, sales are still down significantly.

This thread is getting silly with semantics. It's simple: Prices go up people eventually buy less.

The only thing silly on this thread is your understanding of economics. Prices have been rising for as long as I can remember. Just look at the historical monthly or annualized inflation rates. I went back to 1973 in the tables found here and couldn't find one month, let alone one year, where we experienced deflation. Has consumer spending increased or decreased during that time? Just look what consumers have done over the past six years. Inflation hasn't seemed to bother them all that much.

In the late 70's housing prices we're skyrocketing along with interest rates (rising rates were indicative of rising inflation) yet consumers continued to aggressively purchase real estate. Tangible assets do very well during periods of high inflation. Businesses will also accelerate capital investment spending during these times so that they don't have to pay more in the future. Just the opposite would happen in times of deflation - like the author of this article states.

It's employment, income and GDP growth that really determines consumer and business spending.

The original quote "prices decline businesses sell less" is putting the cart before the horse, even in a deflation environment.

You refuse to accept the fact that the author is speaking about a general decline in prices, which is what happens during deflation. There is no need to qualify what he's saying with the word "even". Maybe the author thought this would be self-evident to the reader. It was to me but he should probably be more specific in the future.

The author is wrong if he believes we're currently in a deflationary environment. That has not been proven....yet.

" money (credit/liquidity) dries up, businesses sell less".

Too many goods being chased by too little money? Sounds like deflation to me. Tomato - Tamahto?

[JPJones]

First you say this (of the 70's)

:Consumers and businesses weren't buying more because of the recession.

You then completely contradict yourself:

In the late 70's housing prices we're skyrocketing along with interest rates (rising rates were indicative of rising inflation) yet consumers continued to aggressively purchase real estate. Tangible assets do very well during periods of high inflation. Businesses will also accelerate capital investment spending during these times so that they don't have to pay more in the future.

Then you say this:

The only thing silly on this thread is your understanding of economics.

Lol, well at least I'm not stating that consumers and business somehow buy less AND more during inflationary periods.

It appears your understanding of economics lacks coherence.

[RobRoy]

The consensus of all the economists I take seriously is deflation now, inflation in the future - possibly hyper-inflation.

[RobRoy]

Printing money is NOT inflationary. Distributing it IS inflationary. As long as it is tucked away in a warehouse, it is as though it does not exist.