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Questions about Deflation

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Jonathan posted on Sat, Jul 3 2010 7:43 PM

Im still trying to understand deflation. Its the absence of buying that causes prices to fall? If deflationary spiral kicks in, how do we prepare? What should we look for that signals thats coming?

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When supply exceeds demand, inventories have to clear.  They aren't clearing at current prices, so they try to clear at lower prices.

Over supply is sort of synonymous with the  absence of buyers when we're talking about PRICE deflation.

Deflation in the Misesian sense is a contraction of the monetary supply, leading to increased purchasing power by smaller units of exchange.

"When you're young you worry about people stealing your ideas, when you're old you worry that they won't." - David Friedman
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Answered (Not Verified) VA replied on Sat, Jul 3 2010 8:07 PM

Yes, with the demand for goods falling prices can and do go down. Moreover, I think you have conflated deflation and price deflation.  

From what I understand deflation is a decrease in the money supply, which can also bring prices down. 

Deflation(decrease in the money supply) causes price deflation(prices going down). Its a game of cause and effect.

In a truly free market, however, prices can and should fall with production increasing in relation to the supply of money. 

If I may make a suggestion, the first few chapters of Rothbard's The Mystery of Banking provides an excellent foundation for supply/demand of goods and money.

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Deflation can also be caused by a lack of money in the system. I'm not exactly sure how it works. I remember reading Milton Friedman or Ron Paul in some book, and one of them was talking about how the Federal Reserve let the money supply get too low, which caused the market to fall around 1919-1921. I think a lot of people on here would disagree with Friedman about his idea that the Treasury should slowly increase the money supply as time goes on.

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Deflation (or inflation) only makes sence from a Misean point of view (a decrease - deflation - or an increase - inflation - of the money supply. With fiat money, deflation is actually very unlikelly, as the central bank, telling us deflation is bad, will prevent deflation. If you think about, inlation (or deflation) as Mises defines it, takes a cause and effect point of view. An increase in the money supply will eventually drive prices up (and vice-versa), from the sense that the overall purchasing power changes accordingly. Money supply increases (cause) and purchasing power goes down (effect). There is absolutelly no point in looking at PRICE inflation or deflation and try to act according to that, as you will be behind the eight ball. In other words, as main stream economics does it, they react on the effect, which is too late to be effective, ignoring the cause. Brilliant. Putting a band aid on a brocken bone.

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Esuric replied on Sat, May 21 2011 9:24 PM

General price inflation and deflation are in no way related to changes in the aggregate demand for all goods and services. An increase in the total demand for consumer goods, for example, is met by a corresponding and proportionate reduction in the total demand for producer goods. In a stationary economy (an economy without economic growth), changes in the general price level are always the result of changes in monetary conditions (alterations in the supply of and demand for money). Of course, general price inflation and deflation can occur when the total supply of goods changes while the money supply, and demand for money, remain stable.

All money prices are a ratio of exchange between economic goods, on the one hand, and money on the other.

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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