Its been pointed out to me that deflation causes incomes to fall and also that debt, in real terms, rises as a consequence. These two factors would combine to retard business investment and therefore economic growth. Is this true?
AdrianHealey: "That's new." Not really.
"That's new."
Not really.
I was being sarcastic.
AdrianHealey: "What is the praxeological difference?" Why do you care?
"What is the praxeological difference?"
Why do you care?
I'm interested to see a perspective I am missing. Is that a problem?
Smiling Dave, thanks for your enlightening post. You are right, that article is a bunch of Keynesian errors. I misread it because I understood "deflation" in an Austrian sense, while the article defined the word in a Keynesian sense. (Phew, this is hard, with all the differing definitions and whatnot.) Deflation is a contraction of the money supply. So an "insufficient money supply" can not be the result of saving, because saving does not reduce the supply of money. Deflation happens when the government has a monopoly on money and won't let us have enough of it. It's like they burned money on a pile, they are actively deflating the money supply. That's the bad kind of deflation and the solution is to not have a government monopoly on money.
TY for the kind words, Nero.
I am not sure why the govt burning up a pile of money is bad. I understand Rothbard's reasoning in What has Govt Done to Our Money, that no matter what the amount of money in existence at a given time, it's fine. The problem is when the govt gives itself free money, nothing else.
From what I remember of Hazlitt's classic work on inflation, he argues that no deflation is inherently bad. The only time deflation causes harm is when it is sudden. And even then, the problem is not so much the deflation itself [what can be bad about increased purchasing power] as the fact that people take a while to get used to it.
Worker: "You mean you are cutting my salary? No way".
Employer: "But your purchasing power is unchanged, in fact it has improved a bit. And I cannot afford to pay you the same dollar amount, because it amounts to giving you a raise".
Worker: "Don't give me that. I'm on strike until you see reason."
Fishwife: "You mean you want me to sell you fish for less?"
Customer: "The money I'm offering has the same purchasing power as before. And I cannot afford to pay you the same dollar amount etc"
Fishwife: Don't give me that. I'm going home until you see reason".
And of course, the Worker and Fishwife will suffer for a while, until they see reason.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
AdrianHealey: A rise in the demand for money is _not_ the same as savings... Would you be so kind as to elaborate a bit on this, please?
AdrianHealey: A rise in the demand for money is _not_ the same as savings...
A rise in the demand for money is _not_ the same as savings...
Would you be so kind as to elaborate a bit on this, please?
Demand for money is far more complex than that...which is why socialism doesn't work, why central banks don't work, et cetera.
One obvious source of a money shortage, manifesting itself as a disbalance toward demand, is when money is horded...for example, the banks that are keeping massive extra reserves right now, because the Fed is paying them interest to do so. They are keeping money out of the economy, creating a shortage of supply that can be described as higher demand. But when energy prices rise, then more money is needed to conduct the very same functions in the economy, which is another kind of increased demand.
In fact, I've just named two of the factors that caused the deflationary, depressionary crisis in 2008. Demand rose faster than supply, because of the Fed suddenly paying interest on excess reserves and because oil reached its price bubble high of 700% of its natural price.
Kaz,
0. You assume there is a "natural price", and that inflation and deflation are both equally guilty of distorting that natural amount. I don't get it. What is the natural price of a thing? If you define the natural price as what the price would be absent inflation or deflation, that does not prove either are bad.
I could define the natural price to be what a thing would cost absent any technological innovations [like shovels] and then "prove" that shovels distort the natural price of things dug out of the ground.
1. Your first argument: With deflation, not all prices fall at the same rate, causing a maldistribution of resources.
There is no need for all prices to rise and fall at the same time. Why should they? When have they ever done so?
Inflation causes maldistribution of resources for the simple reason that it gives the govt a fat pile pile of unearned [= not received in return for some good or service offered] money, which they then use to gobble up resources. How does deflation do that?
Another way inflation causes maldistribution is becuase the way things are set up in the USA, inflation is always accompanied by artificially low interest rates, which sends entrepeneurs a false signal, etc [=Austrian Theory of Business Cycle]. How does deflation do that? It is not connected to artificially low interest rates.
2. Second argument: With deflation, there is an illusion of LESS demand than really exists.
What is the evidence of inflation causing an appearance of more demand than exists, and of inflation causing the appearance of less? All you gotta do is look at the shelves and see what's what.
In classical ABCT [=Austrian Business Cycle Theory] it is low interest rates, not inflation per se, that cause the illusion of less [ not more] demand for consumer goods. Leading entrepeneurs to think that resources are not being spent on immediate consumption, so there will be enough free resources to be invested in long term projects. Why don't they look on the shelves? Because they don't own the stores. So they look at interest rates. But those low interets rates are because there is a glut of paper money in the banks, looking to be spent. How does deflation do any of that?
3. Third argument: If the money is gaining purchasing power every day, I won't spend it. This is bad, because I wont lend, invest, or buy.
Kaz, you gotta eat, right? And pay the rent, and buy a new suit when your old one wears out. Etc etc and so forth. You do not have control of what you need to the extent that you can just stop buying forever, or even delay it for too long. How long will you wait until you break down and buy what you already want? 50 years? 100? Or is a few weeks more realistic?
Historically, there is no evidence for your claim here. People keep on buying laptops and cell phones and TV sets, even though they know those things will be cheaper in a few months.
All of the above is about your claim that people won't buy. As for lending, why won't you lend? You will get your money back later [when it is more valuable, right?] with interest. Sounds like a good deal to me. And why won't you invest? Profits are, by definition, the difference between what it costs a guy to make something, and what he will get by selling it. With deflation, a company's expenses go down, too, so that the profits won't suffer much, if at all. Investing is a smart move in such a case.
4. Deflation tricks us about the relative worth of something compared to everything else.
I don't get this at all. See point 0. above.
Kaz: Demand for money is far more complex than that...which is why socialism doesn't work, why central banks don't work, et cetera. One obvious source of a money shortage, manifesting itself as a disbalance toward demand, is when money is horded...for example, the banks that are keeping massive extra reserves right now, because the Fed is paying them interest to do so. They are keeping money out of the economy, creating a shortage of supply that can be described as higher demand. But when energy prices rise, then more money is needed to conduct the very same functions in the economy, which is another kind of increased demand. In fact, I've just named two of the factors that caused the deflationary, depressionary crisis in 2008. Demand rose faster than supply, because of the Fed suddenly paying interest on excess reserves and because oil reached its price bubble high of 700% of its natural price.
Kaz, we are so far apart in the very basics that we won't gain by further discussion, I suspect.
I don't believe in such a thing as a money shortage.
I don't believe "hoarding" money has a bad effect.
I don't believe that banks sitting on their pile of recently printed money because they can't find anyone who can repay is the same as increased demand for money.
I don't believe higher prices for energy is the same as increased demand for money; quite the opposite.
I don't believe that the crisis of 2008 had anything to do with deflation, or with the Fed paying interest on excess reserves, or that deflation [= decrease in money supply] even existed then.
I don't beleive oil was 700% of its natural price, or that it even has a natural price.
And I don't believe you have explained "demand for money", other than saying it is a complex subject.
You assume there is a "natural price", and that inflation and deflation are both equally guilty of distorting that natural amount. I don't get it. What is the natural price of a thing? If you define the natural price as what the price would be absent inflation or deflation, that does not prove either are bad.
Yes, I assume there's a natural price, as does every Austrian economist. In fact, it's a central theme that arises steadily in Austrian monetary theory.
As I noted, this is HOW the free market works. If you accept the subjective theory of value, where anything is worth whatever someone will trade for it, then that everything has a natural price becomes a truism.
Money's use in an economy is as a tool for determining that natural value as efficiently as possible. If you want to trade chickens for wheat, you have to worry both about the value of chickens, AND the value of wheat, that can vacillate wildly even in a single day. For money to work well, it needs to be relatively stable in value, so that you're really only worrying about the price of the wheat.
This lets the million demands that you weigh every day be measured against the supply of each, and against the demands of the other three hundred million people. There IS an objective balance of all of those demands and supplies...and money helps find out what it is.
This is a basic Misesian position, as well as that of most other free market economists. It was first identified, as far as I know, by Max Weber, but was made famous by Friedrich Hayek.
Even guys like Fisher, who claimed that we need prices to be "stable", wasn't denying the underlying premise that there is a distributed ratio of pricing that is "natural", he just hoped that it could somehow be kept clear even while a central bank was forcing the raw pricing average to be static.
Your first argument: With deflation, not all prices fall at the same rate, causing a maldistribution of resources. There is no need for all prices to rise and fall at the same time. Why should they? When have they ever done so?
We're not talking about them all rising exactly the same percentage in raw numbers, but that they all retain exactly the same ratio to each other, relative to their natural price. In other words, perhaps the need for oak is twice as great as the need for maple, relative to supply, so it costs twice as much per pound. This communicates to the economy that twice as much needs to be invested in oak. If deflation or inflation changes this ratio in favor of maple (maple's price rises faster, or doesn't fall as fast), without changing the actual supply and demand, then you end up with too much maple and not enough oak.
No. That's not even close. Good gods, that's in another universe from Mises, Hayek, even Rothbard's dubious take.
Inflation causes a maldistributino of resources because it blurs the communication balance between supply and demand. People appear to need too much of various things...and worse, the exaggeration varies from one resource to another...so that too much of the wrong things are produced.
This is the most BASIC kind of price theory, universal to pretty much all market economics.
You've taken the normal Rothbardian obsession with the central bank's inflation as the bogeyman that is the sole source of all ill right over a cliff.
Your own wording anticipates the answer to your question:
You are mis-using "interest rates" but in either useage, the obvious correlation is artificially high interest rates. Interest rates, for society to function healthily, need to be at their natural levels, not an artificial high OR low.
Third argument: If the money is gaining purchasing power every day, I won't spend it. This is bad, because I wont lend, invest, or buy. Kaz, you gotta eat, right? And pay the rent, and buy a new suit when your old one wears out. Etc etc and so forth. You do not have control of what you need to the extent that you can just stop buying forever, or even delay it for too long. How long will you wait until you break down and buy what you already want? 50 years? 100? Or is a few weeks more realistic?
Third argument: If the money is gaining purchasing power every day, I won't spend it. This is bad, because I wont lend, invest, or buy.
As with everything else, you could just as well apply that argument to inflation. You present a false dichotomy, where I either buy exactly as much, or nothing.
Again, if it were that simple, central planning would work.
When faced with deflation, fewer people will buy houses, because the money invested in the house is LOST, at its old number, while the house declines in dollar value every year. Had the home buyer simply rented, and kept his money in a mattress, his rent would have declined, but his house payment never does.
The harm of inflation is that you may as well buy that stereo today, instead of saving the money for a rational purchase, because tomorrow the stereo will cost more but you'll not have more.
The harm of deflation is that you should avoid buying the stereo at all, even if it would otherwise be in your personal interest to do so, because it will be cheaper tomorrow, and the next day, et cetera.
Wrong, because that's not deflation. Deflation is either an increase in demand for money over supply, or the resulting price pressure on the whole economy, driving prices downward.
When a price on a specific item declines because of an increase in efficiency, perceived desirability, or technology, that is not deflation. That is natural pricing.
As for lending, why won't you lend? You will get your money back later [when it is more valuable, right?] with interest.
I meant that you're a fool to lend in a deflationary economy because your borrower will probably go bankrupt trying to pay you back.
Why bother lending, when you can just hold onto your money and it becomes worth more?
How is the guy taking a 30 year home loan going to pay make his payments a few years from now, when his income has fallen because of deflation, but the payment is just as big as ever? How is he going to sell the house to pay you back, when the price of the house has fallen faster than he's paid it off?
Right now, we are seeing a massive price decline in housing. This makes lending OR borrowing for, or OWNING a house a really bad deal.
It's deflation in a microcosm.
I am not sure why the govt burning up a pile of money is bad.
So money has a magical condition that is completely removed not only from all the rest of market economics, but from physics? There is a supply/demand curve for money, just like anything else. If there is not as much corn as people need, it's a shortage. If there's not as much money as people need, there's a shortage. This is economics 101.
Fortunately, every Austrian economist disagreed with you.
If, tomorrow, there were suddenly only one dollar, we'd all be fine? Note that the supply of money did not shrink evenly, but the dollar is suddenly all that's left, wherever it is.
If money is simply removed from the economy, it's as bad as if corn, or anything else, is removed from the economy. It drives up demand.
Except that it's not just printed money. The interest payment the Fed is making is identical to the interest it charges on its created money, so they wouldn't bother just borrowing it in the same amounts they are. But money velocity has fallen, because the banks stopped lending or otherwise investing out even existing money, even money they would normally have invested.
What are people going to buy the energy WITH? If it costs twice as much, but we have the same dollars, how EXACTLY is the same amount of energy going to be purchases? And, since almost everything else you buy requires energy, this shortage expands to fill the entire economy.
What you "believe" is dogma that would horrify even Rothbard.
Deflation isn't a change in raw quantity of money. Again, no Austrian economist thought that. Deflation is a shortage in supply of money VERSUS DEMAND. Mises said this, Hayek said this...I don't know of any actual Austrian, or other real free market monetary expert, who disagreed with that.
Then it's you against every real economist out there.
Of course not. If we could explain it, then central planning would work. Explain it, then set up a central bank.
I can't explain the demand for corn, either. Proof of this comes in the form of the massive damage done when the socialists tried to push biodiesel, not realizing they would cause famine in the third world because of rising corn prices. And if we try to compensate for THAT with a different coercion, we'll cause an imbalance somewhere else.
That there is a demand for corn, and money, is a truism. That there must be a supply to match the demand is an automatic extension of that. That the supply can be too low or high is inseparable from these obvservations.
Yep, just as I thought, Kaz. Go on thy merry way.
If the government forces us to exclusively use their money, and then contracts the money supply, it is going to create the opposite of a bubble that's caused by an inflated money supply. Right? Everyone reduces spending while trying to sell off assets, banks don't lend, nobody hires, everyone sits on their money instead of spending and the economy grinds to a halt.
Agreed. In fact, that's a truism.
As I said, every objection to inflation has an inverse objection to deflation.
We can see the effects of inflation from the inflationary recessions of 1948-2002, and the effects of deflationary depressions from 1873-1933:
Check it out:
http://butnowyouknow.wordpress.com/those-who-fail-to-learn-from-history/history-of-economic-downturns-in-the-us
Wow, keep yourself insulated from any conflicting information, or else who knows what'll happen.
Which dogma are you adhering to so cultishly that you can't even expose your confirmation biases to examination? You're certainly not a Rothbardian...Objectivist, maybe?
EmperorNero: I am not sure why the govt burning up a pile of money is bad. If the government forces us to exclusively use their money, and then contracts the money supply, it is going to create the opposite of a bubble that's caused by an inflated money supply. Right? why Everyone reduces spending The whole scenario you paint sounds like you imagine contracting the money supply as the govt dipping into everyones wallet and taking out half of the cash. But of course that is not what is happening. Maybe you are talking about an economy like ours, where people use credit cards freely. Then reduction of the money supply would mean banks have less to lend people, and so the poor folks spend less, since they do not have access to their credit card cash. But that is all to the good. People going into debt in order to spend money they cannot repay is a bad thing for everyone. So in that scenario, reducing spending is a very good thing. while trying to sell off assets, If the govt burned up a pile of its money, it would spend less, gobbling up less resources, leaving more for you ans me and all the businesses and consumers. So prices would fall. Our purchasing power would rise. We will be able to buy more with less cash. Why the need to sell off assets then? banks don't lend, Why not? For a bank to lend, it needs a few things: 1. Money in their vault. 2. Someone they think will pay them back, and who happens to need money. 3. A rate of interest they fell happy with. Which of the above disappears when the govt burns up a pile of its money? nobody hires, Why not? In order to hire, a company needs to feel that the work this new guy will do will pay for itself. Meaning the company makes so much money selling what the new guy has produced that they can pay him and pocket some for themselves. How will the govt burning up a pile of its own money change the companies calculations? everyone sits on their money instead of spending Kaz raised this point. His conclusion was that people will go to their graves not buying a laptop or cell phone, because the day after they die it will be cheaper. Do you agree with that? Or have you some other line of thinking in reply to what I wrote him? and the economy grinds to a halt. In the 1800s we had deflation and a thriving economy.
why
Everyone reduces spending
The whole scenario you paint sounds like you imagine contracting the money supply as the govt dipping into everyones wallet and taking out half of the cash. But of course that is not what is happening.
Maybe you are talking about an economy like ours, where people use credit cards freely. Then reduction of the money supply would mean banks have less to lend people, and so the poor folks spend less, since they do not have access to their credit card cash.
But that is all to the good. People going into debt in order to spend money they cannot repay is a bad thing for everyone. So in that scenario, reducing spending is a very good thing.
while trying to sell off assets,
If the govt burned up a pile of its money, it would spend less, gobbling up less resources, leaving more for you ans me and all the businesses and consumers. So prices would fall. Our purchasing power would rise. We will be able to buy more with less cash. Why the need to sell off assets then?
banks don't lend,
Why not? For a bank to lend, it needs a few things: 1. Money in their vault. 2. Someone they think will pay them back, and who happens to need money. 3. A rate of interest they fell happy with.
Which of the above disappears when the govt burns up a pile of its money?
nobody hires,
Why not? In order to hire, a company needs to feel that the work this new guy will do will pay for itself. Meaning the company makes so much money selling what the new guy has produced that they can pay him and pocket some for themselves. How will the govt burning up a pile of its own money change the companies calculations?
everyone sits on their money instead of spending
Kaz raised this point. His conclusion was that people will go to their graves not buying a laptop or cell phone, because the day after they die it will be cheaper. Do you agree with that? Or have you some other line of thinking in reply to what I wrote him?
and the economy grinds to a halt.
In the 1800s we had deflation and a thriving economy.
If it did, that would be less damaging than what does happen, where the shrinkage is uneven around the economy, hitting some resources differently than others, causing a blurring of the communication of needs through pricing.
What is good is if everyone borrows the amount of money (much, some, or none) that they would be led to do without any outside interference, whether inflation or deflation or fannie mae or the Community Reinvestment Act.
DISCOURAGING borrowing is as harmful as encouraging. The attitude that you know what is good for people better than they, as individuals, do is socialist.
Except it doesn't happen magically like that. POOF, the government has less money, yet we have just as much. No, in fact the government uses its coercive power to shelter itself, while WE end up with less money, even faster than prices fall. Meanwhile, everyone who already owns a house is stuck with a failing investment, everyone who owns a farm cannot afford to expend assets all year in anticipation of the crop at the end of the year, with crop prices falling, et cetera.
Why not? For a bank to lend, it needs a few things: 1. Money in their vault. 2. Someone they think will pay them back, and who happens to need money. 3. A rate of interest they fell happy with. Which of the above disappears when the govt burns up a pile of its money?
First, the money doesn't magically burn. The banks, in fact, hold onto much of it instead. The Fed is paying them interest to hold it, and they find that to be BETTER than lending it.
Right now, we are suffering deflation unevenly (as I pointed out it must be), and one of the most amplified sectors is housing. The banks don't want to lend ANYONE money for a house, because the house will soon be worth less than the loan. Almost nothing fixes that.
And I addressed your reply...but you've fallen into a cultish, confirmation bias sort of behavior of refusing to talk about it any more.
My rebuttal stands. The rational people will read it, and since you are not refuting it, the conclusion is mine.
http://butnowyouknow.wordpress.com/those-who-fail-to-learn-from-history/history-of-economic-downturns-in-the-us/
It boggles my mind that people who claim to know something about economics don't know about the massive history of economic downturns in the 1800s.
The deflation set off by the imposition of the gold standard for the first time in the US, in 1873, initiated waves of deflation resulting in economic depressions that dwarf any recession of the Fed's era of blundering mismanagement.
ITGF,
Deflation is a potential consequence of multiple causes. What deflation causes usually depends on what caused a deflation in the first place, and so talk of what deflation causes often creates more confusion than elucidation.
Centaris paribus, when the economy grows, the supply of goods tends to increase and the general level of prices falls. The purchasing power of each monetary unit increases; debtors will repay lenders with money worth more in real terms. However, the burden of debt does not necessarily increase. Economic growth enables the debtor to produce more with less, and so debtors have no more difficulty maintaining nominal income.
On the other hand, an excess demand for money really does cause all those problems you describe. The money supply (real or nominal) must rise to bring supply and demand back into equilibrium. This is not optional. When there is an excess demand for money, the money supply will increase one way or another and "stimulate" total spending, employment, demand, etc. The only question is whether it will occur through an increase in the nominal or real money supply.