Quote from: michaelsuede on June 30, 2011, 09:02:23 PM

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Deflation is supposedly bad because:

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There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borroweven a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall and its a fact of life that its very hard to cut nominal wages theres downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma. In fact I actually wrote out the exact same three arguments before I even read Krugmans article, but I figured it would be better if I listed them off right from the horses mouth.

So lets address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment. There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time). As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this. Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people. The people in transition are going to be unemployed while they look for new work.

But setting that point aside, we have to look at why money undergoes deflation in the first place! It is not surprising that Krugman doesnt mention the reasons why deflation occurs in a currency. There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1. The economy is producing more new goods and services at a rate that is above the growth rate of the money supply. or

2. In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy! If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods. Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods). Clearly deflation in this sense is beneficial for consumers. We see this taking place in the electronics industry which is largely free from government regulation and subsidies. When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry. You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them! So yeah, in this sense, inflation encourages spending. But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power.

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing. It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings. People who save for their retirement by putting money in a bank would be fools in an inflationary environment.

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now! Boy that sure sounds like a problem we are all familiar with doesnt it?

Krugmans argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future. That is obviously not how people think. People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings. That, by the way, is how a healthy economy should operate. Notice there is no fear involved. Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So you are essentially agreeing with Krugman on spending and borrowing, and vacuously agreeing with him on employment.

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So let us look at Krugmans second argument that deflation makes debtors worse off. What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldnt the savers naturally benefit more than someone who is putting themselves into debt? Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future. This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future. Savings is what builds strong economic foundations. If the US wasnt so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

But also let us consider the impacts of deflation on interest rates. People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase. This leads to falling interest rates. Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend. When banks have a lot of people saving money with them, they will lower rates naturally. This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds.

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles. Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you? Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

You are not arguing against Krugman's point here. Fair enough, as common sense will show his point is true.

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So let us address Krugmans final argument that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power. Who doesnt want that? Further, consider that if you dont get a raise every year, YOU STILL GET A RAISE! Employers dont necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

How would cutting hours work? Assuming the business is being run with reasonable efficiency, cutting hours worked will decrease the amount of product produced, decreasing income, and causing the business to shrink.

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But lets say the economy is so productive that money gains so much value that employers are simply forced to cut wages if this was the case, would anyone seriously give a damn? We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldnt have to work three jobs to put themselves through school, etc etc etc

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

Oh yes, one more thing. I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme. This is the real reason why Keynesian economists fear monger about deflation. Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state). As debt gets wiped out, the money supply decreases which leads to deflation.

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks. To learn more about the scam that is our debt based economy, check out The Case Against The Fed. It offers a clear picture of how the modern banking system operates and why it was created. If you are looking for something slightly more entertaining, yet still informative, check out The American Dream. It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.

So people will be smarter in a society with deflationary currency? This is the only point of Krugman's three that are not so obviously true.

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Keynesian economists like Krugman dont have your best interests in mind when they argue against deflation. They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks.

Seems like they are common sense for the most part.