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Inflation better than deflation?

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Juxtys
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For starters, it's important to say what you mean by those two terms. The term inflation is used to mean one of the following two things:

  • an increase in money supply; or,
  • an increase in price levels

Similarly, deflation can be used to mean either:

  • a decrease in money supply; or,
  • a decrease in price level

It is easy to confuse these two, because they most often come together. However, they are not the same thing. I think the best thing is to drop the term inflation and talk about "price-rise" or "money-increase"; that way, one maintains clarity.

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Inflation helps debtors at the expense of creditors, while deflation helps creditors at the expense of debtors.

In a deflationary environment, debtors face increasing real payments on loans. From the government's perspective, deflation would be a travesty (the US is the world's largest debtor). In the early history of the United States, because farmers were large borrowers, farmers fought deflation by lobbying government to establish the First and Second Central Banks.

Naturally, those who hold some consumption-centered macroeconomic view (most economists today) will argue that deflation is detrimental to economic growth, since it lowers consumption in the current period. Consumers know prices will decline in the future, therefore they increase saving and decrease current consumption. Businesses will also choose to delay purchases of capital goods in anticipation of future price declines, therefore capital good consumption will additionally decrease. Businesses also face other problems in a deflationary environment. They will act to lower wages, which is never easy. Wages, in general, cannot be reduced as quickly as prices ('sticky wage' problem). The result is that business profits may be squeezed and many firms may face bankruptcy.

Deflation is necessary to get us out of the current crisis. Americans have recklessly borrowed and consumed for the last decade, while savings rates have plummeted. This is due to encouragement from government. As Bush said after 9/11 (paraphrasing), go to the mall and start shopping, it's the patriotic thing to do. Meanwhile Greenspan dropped interest rates to spur consumption and did, by creating the bubble in the mortgage market. Deflation, in the current crisis, would potentially wipe out debtors who should not have borrowed. It would also act to encourage saving, which is a crucial component of economic growth.

Edited by adrock3215
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For starters, it's important to say what you mean by those two terms. The term inflation is used to mean one of the following two things:

  • an increase in money supply; or,
  • an increase in price levels

Similarly, deflation can be used to mean either:

  • a decrease in money supply; or,
  • a decrease in price level

It is easy to confuse these two, because they most often come together. However, they are not the same thing. I think the best thing is to drop the term inflation and talk about "price-rise" or "money-increase"; that way, one maintains clarity.

I actually ment both because they almost always follow each other.

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I actually meant both because they almost always follow each other.

But it is important to distinguish money supply increases or decreases versus prices increasing or decreasing due to production. Ideally, the money supply ought to be rather stable over time (in terms of decades) since this is the best way of assuring that what is used for money retains its value over time as a medium of exchange. In other words, for example, it does an economy good for one unit of money to be exactly equal to one unit of gold over time. If the money supply as we know it today, the dollar, is increasing quantity versus the overall quantity of gold, that means each dollar today loses value in the future -- i.e. a dollar back in 1950 was worth a heck of a lot more than a dollar is worth today in terms of how much gold one can get for it (inflation). Similarly, if the quantity of dollars decreased over time versus the quantity of gold, then each dollar yesterday would be worth less than each dollar today (deflation).

The relationship between prices and either inflation or deflation is not as simple as an increase or a decrease in prices, because prices are controlled by production and supply and demand. For example, the continued decrease in prices for, say, computers, does not come about due to deflation -- it comes about due to increases in the means of production that outweighs higher demands for computers. Similarly, the recent increases in gasoline prices was not due to inflation, but rather supply and demand in that particular product.

Unfortunately, our government is going to fight the sudden decrease in gasoline prices by assuming this came about due to deflation, and will pump in more printed dollars into the economy. The Feds have stated this outright. In the long run (maybe ten years if not less) this increasing of the money supply will inflate the money supply and will lead to overall higher prices that would otherwise be experienced across the board in all economic transactions.

The best thing for governments to do is to get out of the money printing business and let supply and demand operate. The more they manipulate the money supply, the less certain anyone can be about the relationship between price and value, whether they are inflating or deflating the money supply.

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Juxtys,

I'll read between the lines and assume that you are asking: why are economists worried about falling prices? aren't falling prices a good thing?

Generally, the argument goes like this: rapid price declines, particularly when unanticipated, hurt producers. For instance, consider a company with $100 equity, $1000 sales and $980 in costs, giving them a 20% return on equity. Imagine that the prices for the goods they sell drops unexpectedly by 2%. Suddenly, they have zero profits. So, what do they do? They cut costs. Maybe they fire a few workers. If this is widespread across the economy, that means a lot of workers losing jobs. This, in turn, means people will cut back their expenditures, out of fear of bad times. That, in turn, means a further fall in prices. And so on.... That is the standard (but flawed) theory.

Better mainstream economists are fine with various types falling prices. For instance, they are generally fine with price declines caused by some economy-wide technology-revolution -- say, the railway, or computerization, or the internet. They get concerned when prices fall merely because "aggregate demand" falls. Here is a document that will help you understand their argument.

Many classical economists criticize the idea of "inadequate aggregate demand". Jean Baptiste Say is well-known for arguing against the notion. This page will give you a summary.

Edited by softwareNerd
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Then I meant the increase/decrease of the amount of money in the supply.

Then it all depends on who you are and what your savings and borrowing activities are. Under inflation, it is to your best interest to get into debt, because the money you pay back is worth less than what you borrowed. Under deflation, it is best not to get into debt because each dollar you pay back is worth more than the dollar you borrowed.

However, as a saver of your own earnings, deflation is better because it means that each dollar you saved is worth more tomorrow than when you first saved it. Likewise, for inflation, it is better to spend your money now because it will be worth less in the future.

The problem is that governments use inflationary and deflationary policies to try to manipulate the average savings throughout the economy. In other words, for either policy, you don't have control over how much you save or borrow -- the Feds or the central bank of your country is intentionally manipulating your money so that you will be inclined to do what they want you to do (save or spend according to what they think is "best for the economy").

I've come to the conclusion that it is best to get the government totally out of the economy, including out of the printing of money. In the hands of private banks, money would be much more stable -- or at least one would have the option of trading in the best money available, regardless of what commodity is backing that money. Right now, at least in the US, we don't have any choice except to use the Federal Reserve note, which is manipulated continuously. One has no idea if one's dollar saved today will be worth more or less in the future (though with their policies, it will most likely be worth less tomorrow).

As to how good it is for the economy as a whole, personal judgments as to whether or not to save ought not be based upon the economy overall, in the sense that you ought to save for your future since the overall economy in the hands of the government is basically unpredictable decade over decade. However, if there was hyper inflation, then don't save and switch to a better money standard, if you can.

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I live in Lithuania, there only one currency exists - Litas(Lt). 1 Lt is now worth about 0.45$. Now, local ecomicians are alarmed about a deflation of 0.1 percent. This happened not due to smaller money supply, but due to falling furniture, oil, lumber, etc. prices, while prices of heating, food, electricity and even bus tickets are still increasing. Of course, my family is not saving money too much.

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Then I meant the increase/decrease of the amount of money in the supply.

I recommend reading Henry Hazlitt's easily-accessible Economics in One Lesson (1946). First, read the "One Lesson". Then, read the chapter on "The Mirage of Inflation". (Don't forget to click on the right-arrow to go to the next sections)

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For the people with money inflation is always better than deflation. For the people with little or no money, deflation is always better than inflation.

spookthegod

He said let there be waves, and it was so, Matthew V 2.0

Actually that is totally wrong.

A person with money would prefer a deflationary environment to an inflationary one, since, in the former, the purchasing power of each unit of money would increase, making his or her dollars more valuable. The opposite phenomenon would occur in an inflationary environment for a person with money.

Edited by adrock3215
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While we're on the topic of money supply, I thought I would have a question understanding.

If we existed in a laissez-faire capitalist system with the government divorced from economics, how exactly is money produced? I assume it would have something to do with banks ordering it from a minting company, but I'm not sure how exactly the process would work.

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If we existed in a laissez-faire capitalist system with the government divorced from economics, how exactly is money produced? I assume it would have something to do with banks ordering it from a minting company, but I'm not sure how exactly the process would work.

If we are talking about non-fractional reserve banking, then basically, the bank would take in gold and send it to a mint to have coins or bills made from it. The bank could make it's own money, by stamping gold into coins or by printing bank notes backed by gold (or some other commodity), but it wouldn't order bills or coins without paying for them. As I understand it now, there are occasions where banks do not give anything to the Federal Reserve and get money from them; they might pay it back in terms like a loan, but the bank does not give anything to the Feds to be converted into money, which grossly distorts the amount of dollars out there (inflation).

So, there is no complicated means of the bank getting money from a mint under capitalism: Gold is taken in and the mint presses them into coins (for a fee) and then the bank has the gold in unitized quantities that it can then loan out for a profit. In other words, the mints would not be making gold coins or printing bills unless someone provided them with the raw materials from which to make money.

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  • 2 weeks later...
I live in Lithuania, there only one currency exists - Litas(Lt). 1 Lt is now worth about 0.45$. Now, local ecomicians are alarmed about a deflation of 0.1 percent. This happened not due to smaller money supply, but due to falling furniture, oil, lumber, etc. prices, while prices of heating, food, electricity and even bus tickets are still increasing. Of course, my family is not saving money too much.

What you can do is buy gold with some of your savings. Gold has traditionally been able to counteract inflation helping to preserve the value of your savings. It's a two-edged sword though, because your local grocery store likely only takes your currency so putting too much of your savings into gold could work against you (in the short -term) in deflationary times...but for very long-term horizons (10yrs plus) it's nice to be able to have a stable hedge like that.

Governments provide a huge question mark here too though...the uncertainty is what makes it nearly impossible to have a long time horizon in both precious metals (for fear of confiscation) and national currency (for fear of inflation). You are put in a position where you have to act on rational principles and then fight to preserve the value you created.

If we existed in a laissez-faire capitalist system with the government divorced from economics, how exactly is money produced? I assume it would have something to do with banks ordering it from a minting company, but I'm not sure how exactly the process would work.

It worked fine in Canada and the U.S. when central banking was a minor issue. The few regulations that did exist prevented banks from having a clearing house (which would have solved the perceived "instability" of the banking system then).

A localized exception to the rule was the Suffolk system in Mass which really didn't suffer the same kinds of problems that other banks did in regards to an internal clearing and bank note exchange system. Also check into banking in general pre 1913. Every problem originated with the fact that State laws prohibited interstate branch banking and a clearing house system.

Banks did temporarily inflate their bank notes, but the system still worked great, and I think it was because any expansion of those bank notes was governed by supply and demand and was kept in check by reality. There was no arbitrary inflation. As a result, the value of money was relatively stable.

Edited by prosperity
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  • 2 months later...
I always though that deflation is better than inflation because it makes your saved money to have more value. But I encounter people who think otherwise. So how's in reality?

Read this piece by George Reisman: http://georgereisman.com/blog/2009/01/fall...ntidote-to.html

That should clarify it for you.

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