We've Already GOT Deflation - The Only Question is Whether It Is the Good Kind or the Bad Kind → Washingtons Blog
We've Already GOT Deflation - The Only Question is Whether It Is the Good Kind or the Bad Kind - Washingtons Blog

Thursday, November 20, 2008

We've Already GOT Deflation - The Only Question is Whether It Is the Good Kind or the Bad Kind


In an article entitled "Deflation: Disaster or Just A Nice Discount?", the Wall Street Journal says we've already got deflation:

When economists think deflation, they see looming disaster in the form of Japan’s deep recession of the 1990s or even the Great Depression.

But when U.S. households see deflation, they might just notice a little extra money in their pockets.

Right now, deflation appears to be that latter, better, variety: Every day is a sale.

How can the Journal say we've got deflation "right now", when many economists are debating about whether we'll get deflation some time in the future?

Because people use the word "deflation" in different ways.

Everyone agrees that deflation is negative inflation. One economist writes:
Economists define deflation as a decline in the average price of the products and services in a market.
Well, we certainly have a decline in the average price of goods and services right now. The U.S. has actually experienced many brief periods of deflation, so this is not uncommon.

Many people define deflation as a "persistent decrease in the general price level of goods and services." But no one agrees on how long deflation must be to be "persistent".

In fact, while they won't admit it, I believe that whether or not economists think we've got deflation comes down to whether they think we've got the "good" or the "bad" kind of deflation. Not on whether or not average prices or falling or the number of months they've been falling.

For example, the above-quoted Wall Street Journal notes:

What the Federal Reserve has to avoid is the kind of chain reaction that ensues when consumers and businesses expect prices to keep falling, leading to a downward spiral of lower spending and job cuts.***

As long as expectations for future inflation remain anchored in the 2% range, then falling prices are likely to remain the kind of price shock that benefits consumers, who are less likely to put off spending in hopes of getting a better deal later.
Just as the government and media kept asking "will we get recession" long after we were already in recession, they've avoided mentioning deflation so they wouldn't scare people.

We've already got deflation. The only question is whether it is the good kind - where consumers get a price break - or the bad kind, where the economy crawls to a standstill because no one is buying and employers slash wages and jobs.

The Austrian school of economics defines deflation as a shrinking money supply, and considers falling prices as simply a symptom of the smaller money supply. Personally, I agree with that definition. See this for more information.

4 comments:

  1. I'm not too knowledgeable in economics, but it seems to me that the raw numbers of prices isn't the best indicator of a collective entity's financial health. Shouldn't it be framed in the context of real prices - i.e. what people can (and do) buy with what they earn? That is, how price changes affect the standard of living?

    As an obvious example, in the computer industry prices for the same item/performance/service consistently and often dramatically decrease in a short period of time, which is a good thing - we can buy more for our money. If this phenomenon were true in all sectors, prices would fall across the board. Perhaps wages would also fall as a result, but the buying power and standard of living would increase (and possibly sky-rocket).

    So, the question is: are we getting more for less? Or less for less? The former can be a long-term phenomenon, provided it's due to long-term planning and not (panicky) loss-cutting.

    The latter is not sustainable. Obviously, fewer people are buying right now. For forecasting purposes, their reasons for saving are important to identify. In the short-term, producers are motivated to cut prices. If that doesn't elicit enough sales, producers will be motivated to produce less, so eventually there's going to be less to buy. Then, those that still want to buy will face higher prices (real prices), especially for goods in industries that utilize economies of scale. And across the board, if people's finances continue to be pinched (due in large part to contracted credit), then people will either be unable or unwilling to shell out for as much stuff. So it becomes 'less for more' - i.e. inflation. Yes?

    Sounds like a contraction of the economy to me. Isn't that what (the bad kind of) deflation is supposed to signal?

    This is why I think any "spending stimulus" plan is bollux. It doesn't recognize the fact that in a certain sense, supply actually produces demand; oftentimes companies have to educate consumers as to why their product is useful and valuable to them - i.e. how it makes their lives better. Of course, it has to be done smartly, i.e. taking into account the values, priorities, and financial context of likely consumers. Which is why propping up a bloated, inefficient, out-of-touch company or industry (I'm speaking to you, Detroit), is also a bad idea. You can't force people to consume, at least not for very long.

    Apologies for length....

    ReplyDelete
  2. Actually, I changed my mind on that last point. You can't force people to voluntarily consume, but you can force people to part with their money against their will, and give it to companies/industries in defiance of consumer values, priorities, and financial context. That's what the government is doing - using taxes (confiscated money) to give to whatever industry is begging at the moment, attempting to take the place of consumer spending. But government spending is fundamentally a different thing from consumer spending, and the realities of that will never go away. You either play by the rules of reality, or shoot yourself in the foot until you learn (or die).

    Hey, Washington: there's a reason we're not spending. We can't afford it. So neither can you.

    ReplyDelete
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