Is deflation "worse" than inflation?

When you are in a period of deflation people hold off buying goods and services on the sure knowledge that if they wait a while those goods will be available at a lower price. This then decreases trade and the flow of money which results in people lowering prices yet further to attract trade and you can then end up in a deflationary spiral. Is it worse than inflation? Yes, all economies depend on a certain level of inflation. The problems with inflation arise when you enter a period of hyperinflation as was seen recently in Zimbabwe and very famously in the inter war period in Germany where people burnt bank notes to keep warm as they were so worthless in comparison to wood and coal as fuel.

It’s a GQ. Your read on “professional economists” ... and the politicians that they normally work for… is a good one. They definitely do fear “deflation”. They have a bias towards ‘moderate inflation’ because it works for them. It’s a hidden tax on all of us that is more or less unremarkable when it’s in a ‘normal’ or ‘acceptable’ range.

Think about this: My parents, and presumably yours as well, used to recall when bread was a nickel for a loaf. I certainly recall when gasoline was worth under thirty cents a gallon. What has changed? Bread is still made the same way it’s been made for hundreds of years. Gasoline has a few more additives now, but it’s still just a distillation of petroleum, made more or less the same way for a hundred years now. I realize that gasoline is a worse example because of various political factors as well as a perception of scarcity. (But that’s just a perception world production of petroleum products is at or near all-time highs. It’s not scarce.)

So let’s stick with bread. Wheat flour and a few other ingredients, baking, slicing and packaging. That’s bread. What has changed between bread that used to cost $0.05 per pound and today’s bread that costs $2.50 or more for ‘basic’ bread?

What’s changed is the money. The bread is as good as it has ever been, maybe a little better, in fact. Fifty times better? No. The money has been degraded by inflation by a factor of 50 in less than 100 years. Almost without comment, except for a few newsworthy war years… and the 1970s.

Who benefits from inflation? The people who get the ‘new’ money first, namely politicians and the Fed. They get to spend it on their pet projects and build their power bases. The people who get money ‘last’ ... those who work for wages and invest, get screwed. But quietly, to the ‘acceptable’ tune of about 3% per year. No muss, no fuss, no demonstrations in the streets, and practically no blame or accountability.

Obama gave a perfect example of it with “stimulus” ... everyone receiving “stimulus” case gets ‘new’ money, which makes the ‘old’ stock of money worth less. When that new money works through the various paths it follows and finally finds its way to wages it will be worth less, but no one with a job will complain. (Obama isn’t the only president to do this, of course; they all do it. He’s just the one doing it now.)

Deflation benefits producers and wage-earners directly… and first. It increases their own powers of self-determination. Politicians hate that. And they especially hate that they no longer have the wherewithal to reward their friends… and make new ‘friends’.

Yes, deflation is horrible. It creates a freezing effect on consumer spending, not to mention things like paying back your mortgage will “cost you more” over time. As @CyanoticWasp mentioned, having a small amount of inflation is ideal.

@CyanoticWasp A lot of what you say makes sense, but doesn’t this assume that inflation is a result of an increase in money supply? If its a result of an increase in the velocity in money doesn’t affect all at around the same time (or even normal consumers first)?

I would think the same would be true of deflation. I.e. deflation from a decrease in money supply would affect the fed, etc… first but if it results from a decrease in velocity then it affects everyone around the same time.

I might be confusing some things… and as @RareDenver‘s post makes clear, I need to take into account international trade. So, if imports are greater than exports more money will be outside the US and this results in a decrease in money supply, but one that affects consumers right away…

Which is not to say deflation doesn’t have other problems, but I’m trying to sort out your “who gets affected first” logic.

Good point, @roundsquare. There are differences between the money supply being “stimulated” artificially (as it has been in the US since 2008) by simply creating new fiat money via the Fed, for example, and the money supply appearing to grow because of increased commerce, i.e., “velocity in money” as you put it.

In the first case, the money supply is being added to by creating money out of nothing… no demand for it exists, and the Fed / government collude to create or induce demand for it that wouldn’t exist without their machinations. But that money does get to those who are politically connected to be in a position to use it, however badly. As it moves through the rest of the economy it corrodes the value of what little you and I (not politically connected) have in our pockets or bank accounts.

On the other hand, as economic conditions improve and commerce increases throughout the entire system, the money supply grows naturally then, both because of its increased velocity and because of its ‘natural’ growth through the demand of (mostly) private users who have explicit plans for it… to increase their own wealth. Prices are also driven up in that economy, but that’s because of demand for the products, and not because the money is being debased day by day.

Deflation is an economic nightmare. When there is deflation demand falls since consumers wait to buy goods and services at lower prices. With demand falling supply subsequently rises causing prices to drop further. WIth inventory building up, firms lay off workers since there is no need for them- unemployment rises.

The aforementioned reasons are why the Fed is injecting money into the economy (Quantitative Easing) and not worried about inflation occurring.

I respectfully disagree, @Zag_grad2010. ‘Gradual’ deflation is no more damaging to the economy or to any of us than gradual inflation. In fact, I would say that it’s a sign of increasing prosperity (whether it’s a cause or not—I don’t know that). As evidence look at pricing for electronics in general, and computers in specific, and telephony.

Electronics have been getting cheaper in absolute dollars for years and years. My first stereo system in 1972 cost me $350. I remember it well, because I recall how long I had to work for that thing. That entire system is blown away in quality by an iPod that I can pick up for less than $300 now.

Computers are another example. My first ‘real’ computer around 1987 or so had a 40 MB hard drive that by itself cost me $400. I can buy a laptop today, brand new, with a several-hundred GB drive for less than $400.

Telephone charges are another example. When I was a boy, “calling long distance” was a big deal. We had to plan whether to make “station to station” calls or “person to person”, because the charges were so much higher for person to person. Not everyone could afford a phone in the first place. When competitors to ATT came along and offered “cut rate” long distance it was a huge boon for consumers. Today, people who can’t even afford groceries have telephones in their pockets. If they just time the calls properly, long distance is usually free.

Now, you might argue that these are cherry-picked examples that don’t illustrate ‘real’ deflation. And I admit that these anecdotes and these industries are not universal—but they are illustrative of what happens in deflationary economies. I could probably wait and get an even better buy on another iPod… but when I want an iPod I buy one. There is no lack of computers these days, or telephones, either. The producers of those goods may not be making as many (the falling prices are a signal to them that the demand is letting up, after all, which is how prices communicate through markets), and they may not be making the same profits. But if they are rational producers, it’s likely that they still are making the same marginal profit, because the decreasing prices for their product reflect back through the system to their own suppliers.

And now that I’m back here again, I want to go on record as not being in favor of moderate inflation, as @gorillapaws incorrectly read. I’m never in favor of it when the economy is manipulated in that direction by government action.

@CyanoticWasp Is the type of thing you are talking about really deflation? As technology improves, the supply and demand profiles change which is what is leading to a decrease in price.

What is the traditional argument in favor of mild inflation?

No, that’s not deflation of the money supply, of course, but it’s the real-world equivalent. If you want a computer today but you know that they’ll be cheaper tomorrow, next week, next month, next year, do you wait for it forever to get cheaper? I could have put off buying my 1987 computer… I could still be putting it off if absolute lowest price were my main object… but why do that?

The point is that as humans working and living in the various environments we have, both natural and man-made, quick and drastic changes in any direction are unsettling and hard to adapt to. But I think gradual deflation would be no more upsetting than gradual inflation has been… and it would indicate a condition where money was becoming more valuable over time instead of less valuable. I think it would be a good thing.

The only argument I know favoring mild inflation is the one you’ve seen already in this thread: “deflation is so awful that it’s inconceivable! we mustn’t go there! anything is better than that!” and so on. If anyone presents a rational argument for a coerced (i.e., ‘artificial’) mild inflation, then I’m all ears.

@CyanoticWasp I agree it shares some of the same properties. But there is a big difference. In a deflating economy, the price of (almost) everything will drop by (about) the same amount. On the other hand, even in the case of mild inflation, we would expect the price of technological items to drop because they are constantly improving (i.e. because marginal cost goes down and demand drifts to other items). Of course, the effect of rapid inflation could potentially outweigh this but then the price of the technology would just rise slower.

The only response I can give to that is, “So what if prices for ‘everything’ do drop?” Is that such a bad thing?

My examples served to illustrate that it’s possible for improvement in goods and services combined with decreasing prices. (Consider that this technological and price improvement all happened while general wages and most other associated costs were increasing!)

In an economy with a gradually deflating money supply, which I think would be natural in any case as a population ages, shrinks or otherwise ‘cools’, then prices (and wages) would seek an equilibrium. Then if the economy started to grow again, inflation would grow with it.

From what I can see, ‘natural’ inflation and deflation are just another type of price signal that shows the general direction of the economy, neither causes of improvement or degradation. When you’re driving, for example, and the conditions get worse, you slow down the car. It’s not your slowing your vehicle that led to bad conditions.