Does Deflation Spur Consumption? (Contrary to conventional Wisdom)

in economics •  2 years ago
How many people have heard the claim that we need to increase inflation to motivate people to spend today rather than save for tomorrow. The idea behind price inflation is that people are better off spending their money today rather than saving it for tomorrow. I would like to put forth a theory that economic deflation maximizes consumption. Monetary inflation merely forces people to save by other (less efficient) means. The loss of economic efficiency of savings means people must consume less so they can maintain the same level of real savings after all inefficiencies.

People Need to Save

As much as mainstream economists like to promote the supposed societal benefits of increasing spending, living breathing people need to save. Without savings people are forced to join the rat race and live paycheck to paycheck. A single bad-day, loss of job, or economic dislocation can leave these people helpless.

Regardless of what monetary policy you deploy to encourage spending, the market will respond by shifting savings from money into other, less efficient, higher risk vehicles. Savers see inflation and instead opt to buy and hold inventory or take speculative bets on individual companies and debtors rather than less risky bet on the economy (via money). Meanwhile governments tax inflationary (artificial) gains which eats into the savings principle.

The more the government attempts to interfere with savers ability to save, the greater the extremes actual savers will adopt in order to prepare for the future. The more costly it becomes to save, the more capital must be diverted into the attempt to save.

Deflation Prevents Hoarding

In a deflationary environment people face an opportunity cost by holding on to resources. Businesses that maintain a large inventory lose money each day they refuse to lower prices. It only makes sense to hoard inventory if you expect a future scarcity of a resource to keep the price rising faster than the currency is deflating. Anyone who withholds labor today will make less tomorrow so people will no hoard their labor. Those with oil, gas, lumber, or other natural resources will sell today before the price falls further.

Consumers are more inclined to spend as a result of falling prices. What store advertises "rising prices" in order to sell more product today? Only in circumstances where there is a hard deadline and little competition can merchants advertise rising prices and motivate some people to spend earlier.

Inflation Motivates Saving (in non monetary assets)

In the face of rising prices, people are given the economic signal that they will need "even more" for retirement. They will feel poorer which in turn will induce them to save. In an economy designed to make savings difficult, it will force people into risky investments in things they don't understand. In an attempt to save for their future, people end up being lucky to break even after inflation, taxation, and defaults. The people who profit from this are those offering risky investments: borrowers, companies offering IPOs, and speculators.

Conclusion

No matter what economists claim about consumption driving the economy, their interventions can only make the economy less efficient and therefore consume capital. The more capital that is consumed the more people need to save and the less they can actually consume.

Saver's gonna save, they need to. Only price deflation can motivate a saver to consume today. Only price deflation can motivate producers to lower prices quickly to move their product. Only price deflation encourages people to unload losing investments quickly and reinvest elsewhere.

Inflationary monetary policy can only make savings less efficient and therefore increase the amount of capital directed toward savings while reducing the amount of capital that is actually effectively saved.

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@dantheman Nice ideas. I mostly agree with your ideas about the positives of deflation vs. inflation but I think that in a deflationary environment people tend to become aggressive because they feel they have less money than the others. In addition, there is more risk of more centralization of money. In a deflationary environment money supply is shrinking so if a few people have most of the money supply then the rest will want to overpower those people more. Therefore we risk to have even wars if such an environment persists. Bitcoin will never become a world currency due to its limited money supply and deflationary nature. Few people would own a lot of purchasing power at the expense of the majority.

On the other hand in an inflationary environment when money is printed all the time (money inflation), people do not feel poor (even if their purchase power is lower) and therefore wars and rebellions are avoided.

My conclusion is that neither money deflation or money inflation is good or bad. The equilibrium is better. Market always figures out this equilibrium but some times with delays so intervention on the money supply should always be a solution but not a necessity. Everything is not mathematics and economics but also psychology and human behavior which some times may be received as irrational by the majority.

Interesting.

In a deflationary environment people face an opportunity cost by holding on to resources.

Perhaps I am misunderstanding - I'm no economist, but doesn't deflation mean that the money or capital that you have today will have more buying power tomorrow?

If that is correct then wouldn't that encourage people to hoard and wait longer before spending?

People do not always act rationally so I don't know if it would affect their behaviour in that way am just not getting your reasoning on this.

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Money is not a resource. Deflation encourages people to sell resources (actual tangible stuff) to hoard intangible money. All trades only cause resources to change hands. The goal is to move physical resources to the highest purpose the most efficiently.

Hoarding money is a virtual resource which means it is not interfering with allocating of physical resources.

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OK thanks for explaining:)

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That's a powerful comment.

All trades only cause resources to change hands. The goal is to move physical resources to the highest purpose the most efficiently.

I sometime feel so angry when I think about those guys i.e. Federal Reserve that creates currency money out of thin air and can wager so much power over who gets what but in recent weeks I've mostly been filled with enthusiasm thinking about Steem and it seems like Steem could possibly dilute Fed's power a lot more elegantly that I could ever hope.

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If you are in the market to buy a computer, smartphone, or television today, you can be reasonably sure that waiting 6 months will get you something better at the same price, or the same item at a lower price. Yet those industries thrive. "Hoarding" is just another bogeyman illusion used by scaremongers who want to make excuses for their interventionist policies that plunder the productive economy.

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There is real inflation/deflation and price inflation/deflation.
Real inflation/deflation is directly tied to money supply. When there is more money, it is inflation. When there is less, it's deflation. It really is that simple. Generally speaking, money loses buying power during inflation and gains buying power during deflation. Other factors might change that and it's not equal across all sectors or products/services, due to the forces of supply and demand.
Price inflation/deflation is simply a change in the price. If it goes up, it's inflationary. If it goes down, it's deflationary. This is almost invariably tied to the forces of supply and demand.
There is a great deal of confusion regarding this, because economists (and wannabees) often simply use the term "inflation" to refer to rising prices. That's inaccurate. They should refer to this as price inflation.

Consumers are more inclined to spend as a result of falling prices. What store advertises "rising prices" in order to sell more product today? Only in circumstances where there is a hard deadline and little competition can merchants advertise rising prices and motivate some people to spend earlier.

That doesn't sound true. Do the words "buy now and lock in this great deal" not sound a teensy bit familiar to you? Sellers use this tactic all the time. I don't know if it works - but many many people seem to believe that it does.

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I attempted to acknowledge that it works for "big price jumps". But "buy today and save 3% over NEXT YEAR" is meaningless. Those deals only work when the savings over a short period of time is large.

It's awesome people are waking up to the crazy argument that slyly forcing people to spend will somehow make society richer. The underlying rationale is childish and forcing people to consume more than they'd prefer today means they have less to do so tomorrow. The magical wealth gains offsetting this obvious loss are dubious at best.

I'm of the camp that mild deflation is natural in an increasingly productive world and also beneficial in that it gradually increases purchasing power. That said, I'm skeptical of flipping the inflation argument and being pro-deflation.

"As much as mainstream economists like to promote the supposed societal benefits of increasing spending, living breathing people need to save." Absolutely! And they also need to consume, the split best left to individuals to decide.

I agree with your writings. I myself have been telling people that we need a sustained period of deflation as well.
Resteemed!

"Inflationary monetary policy can only make savings less efficient and therefore increase the amount of capital directed toward savings while reducing the amount of capital that is actually effectively saved."

I don't think anyone can logically argue with that, but you will never here it out of a krugmans mouth.

I see a balance there.

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Yeah. Forgot to check it before submit.

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Oh no not the post payout, The topic of your discussion. Having deflation prevent hoarding and inflation motivate saving. Don't worry keep forgetting to check it before for you submit though :)

@dantheman Necesito que me ayudes con un inconveniente en mi cuenta, por favor decime como puedo contactarte.. Gracias!

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I think there is something missing in your sentiment.

If we look at inflation vs deflation, to me it is the same coin, with two different sides. Inflation means you need to hoard assets (stocks, real estate), deflation means holding money itself is profitable.

In both situation things are artificially made worse or better to invest in.

This to me is the issue with both inflation and deflation. Value is automatically transferred within society. What is needed is money of stable value. Anything else is suboptimal.

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Dude. You are confusing price inflation with supply inflation and therefore you cannot understand the article.

The only way to have price stability with a growing economy is to have monetary inflation.

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No I am not confusing monetary supply with inflation.

I am not saying I don't understand the article, but that it misses the point.

Both inflation and deflation are counterpructive. Arguing that delfation is good even though we have been taught that inflation is good misses the point, while every one of your arguments is technically correct.

Am I making sense?

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You keep using inflation and deflation without specifying monetary or price.

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I just mean inflation/deflation. not sure why you think i mean money supply.

Again my point is that from a productivity perspective both directions are counterproductive for the ecology - just in opposite way but with the same effect.

Let me know if you disagree. I'm just here for dialog and to learn. Feel like you are attacking me and don't quite understand why?

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To be clear inflation to me is always price inflation. I.e. If a product service cost less over time that would be deflation, more inflation. Money supply on the other hand is just something that impact price, among other things. It is possible to have deflation with increased money supply and vice versa. I would not say that steem has an annual inflation rate of 100% vs. 9.5% after dec. 6th. I would consider that statement to be technically incorrect