Thursday, 8 January 2015

Economic Myths: Deflation leads to a downward spiral

From e.g. Moneyweek:

Ben Brettell, senior economist at Hargreaves Lansdown... adds: “If deflation becomes entrenched and consumers begin to expect prices to fall, it can be dangerous. Spending decisions will be deferred in expectation of lower future prices and economic stagnation could result.

What a load of drivel.

Most of the stuff you buy because you need or want it now, today, this week, this month. You can't just go without food to eat or petrol for your car for a year, even if you are 100% sure that the price of food or petrol will be significantly lower in one year's time.

Consumer electronics is the perfect counter-illustration to this, people have been merrily buying new stuff every year, even though by now most people assume that what comes out next year will be bigger, better, cheaper etc.*

Further, the sort of price deflation they are talking about is minimal, a percent or two a year. If you are planning to buy a new car for £20,000-ish sometime in the next year or two, is that £500 potential saving from deferring your purchase really going to make much of a difference? Methinks not.

This effect can only happen if...

a) You are thinking of buying a speculative asset, such as land. Your total land consumption doesn't change (you are renting instead of owning in the interim) and land rents are not an addition to the economy, they are a transfer.

b) the benefit you'd get from having something for a year is less than the amount by which you expect the price to fall. And I struggle to think of an example for that, it can only apply to completely non-essential things, like a high-powered telescope for star-gazing or something which you'd only use once or twice a year.

UPDATE: now I think about it, this myth is quite similar to the myth that the government can boost the economy by pushing down interest rates. It's the same fallacy in a different guise, and of course has to be perpetuated as an excuse to prop up 'asset' values (i.e. capitalised rent and monopoly income).

* This is not actually true any more, I reckon we have passed the point of peak technology in many respects. Nowadays even Apple can't resist adding on extra bits and extra pieces, none of which really work properly.

Mobile 'phones reached perfection about nine years ago with the Nokia 1110. Everything since then was bullshit, and given how small UK housing is, there's no need for a TV bigger than 40". But most people still believe it.

29 comments:

paulc156 said...

Hmm, I wonder... I must admit to waiting as long as possible at the moment before filling my tank with ever cheaper petrol and I definitely delayed purchase on my first home computer [XP]as you could get ever more for your money the longer you waited, though I was a bit cynical about computers back then. Now for things like food you just have to eat so no one is going to delay that, but if you thought cars would be a bit cheaper in a few months time, or property prices were about to fall, I think delaying the purchase if at all possible would be entirely rational.

Lola said...

I was having this exact same 'discussion' on line, and most worryingly, among my peer group...

Robin Smith said...

It might be worth defining what you mean by "deflation" at the start. Else one tends to end up begging the question.

Deflation = when the ratio of currency units at the current expected economic value, versus all goods and services, falls.

For example its perfectly OK to remove money from the economy if the ratio falls, WITHOUT there being deflation.

Likewise its also fine to inject more into the economy without causing inflation.

The question everyone avoids because that makes everyone complicit, is what is meant by the term "value" in the economic sense?

So progress on the matter is never made. Funny.

Robin Smith said...

It might be worth defining what you mean by "deflation" at the start. Else one tends to end up begging the question.

Deflation = when the ratio of currency units at the current expected economic value, versus all goods and services, falls.

For example its perfectly OK to remove money from the economy if the ratio falls, WITHOUT there being deflation.

Likewise its also fine to inject more into the economy without causing inflation.

The question everyone avoids because that makes everyone complicit, is what is meant by the term "value" in the economic sense?

So progress on the matter is never made. Funny.

Robin Smith said...

It might be worth defining what you mean by "deflation" at the start. Else one tends to end up begging the question.

Deflation = when the ratio of currency units at the current expected economic value, versus all goods and services, falls.

For example its perfectly OK to remove money from the economy if the ratio falls, WITHOUT there being deflation.

Likewise its also fine to inject more into the economy without causing inflation.

The question everyone avoids because that makes everyone complicit, is what is meant by the term "value" in the economic sense?

So progress on the matter is never made. Funny.

Steven_L said...

They like to make the old diagonal comparison - Japan - a nation that ran a large trade surplus and a fiscal deficit for years.

In those macro-economic conditions, how could there not be a high net private sector savings rate?

We all know that they mean 'inflation' is prices but not rents/land values rising and 'deflation' is when rents/land values fall.

Derek said...

Mark is right. The economist is talking nonsense. There are some thing you can put off buying and some things you can't. Deflation makes the price of non-essentials fall because a shortage of money causes people to concentrate on the essentials, such as food, rent and debt repayment. It's not people's expectations of falling prices that cause the problem: it's too much debt and too little money.

Ian B said...

Well, indeed. I've said this often myself. It's part of the myth of the ecomomy being driven by certain inflating prices *cough* land values *cough* and it's terrible if they fall. It's terrible for people hoping they'll rise, of course. Boo hoo.

Economic growth *is* deflation. It's getting more stuff, for less money, year after year. For the past century they've been masking that by inflating the money supply, and they're terrified that people will learn to live without inflation, and then... asset prices OMG oh noes armageddon.

Robin Smith said...

Loads of prejudicial confusion here. I wonder why :)

Lola said...

RS. Well, yes. So inflation/deflation are always monetary phenomena then?

Capitalism is all about doing more for less every day. Quality up / price down - same thing. So 'price' deflation is the natural order. Only it isn't 'deflation' at all. It's just stuff getting better all the time.

It's this they deliberately won't get their heads round.

What 'deflation' is V bad for is indebted governments buying votes with bad money raised by issuing bonds. It's not a market problem, it's a government problem.

Robin Smith said...

Lola: With all ue respect. No. Money is the common measure of value and the common means of exchange. That is all it is. A proxy for capital. Capital is the stuff you buy with money. So if we still have out marbles we dont want money. We want the stuff we buy with money. Alas the whole world is asleep on this child understood fact.

Socialism is also about geting what you want with the least effort. But its not limited to stupid religions like capitalism or socialism. Its a fact of nature in democracy and tyrany (not much difference)

Deflation can only happen if more capital is produced for the same amount of money in circulation. Visa versa for inflation. All capital depreciates so it has to be replaced with at least the same amount to stay evens. History shows it always has. That most of its used to buy real estate today (mortgages) is why eventually the whole system defaults. Its inflation because the capital is not being replaced yet there is more money circulating.

So to prevent both happening (apart from LVT which would do it too but causes world wars)(stable functional economy) ... create more money relative to productive growth. And tax it away during recession (which has never happened over the long term except when civilisation is in decline like the dark ages after Rome when the Christians took over in AD 350 and then it wont happen anyway as things are in chaos already)

Government are superficial. Its the people and that is the profound nature of the problem we are all ignore by selecting special cases to blame like religion does.

No government was ever elected by a minority. And for those who say "I didnt vote" ask them if they gave back any of the gains they made from the government they didnt want?

Let me know if you can remember any exceptions to this.

Mark Wadsworth said...

PC, OK, you delayed filling up with petrol for a few days. That's not even a blip in your spending patterns.

The rule DOES apply to purchase of speculative assets (land, shares) but they are not an addition to the economy, they are not 'produced' as such.

L, exactly, surely a child of ten can see that it's nonsense: "If you know that a computer game will cost £10 second hand in a year's time and £30 now, would you wait a year before buying it?". Well of course not (if my kids are anything to go by).

SL, good final point.

D, another good point. They've confused cause and effect.

IB, that's the same as what SL said, I think, but a bit more forcefully.

Bayard said...

Deflation must be up there with LVT as Things That The Government Doesn't Like, so we can expect the same degree of bullshit to be spouted about it.

Lola said...

RS. Mate, that is one massively muddled post. I think you are seriously confused about inflation / deflation. Which is not surprising as so is everyone else post Keynes.

Robin Smith said...

Lola, darling. I see. Rather than pass summary judgement tell me what you feel is muddled, starting with the most muddled piece first and why you feel that way?

The best way to approach it is not to speed read it and do it in a quiet moment. Go through one piece at a time pointing out what you do not understand and I'll clarify for you.

Lola said...

RS. I have. I really can't be arsed.

DBC Reed said...

Everybody is forgetting that in deflation wages go down as well.There is less production because there is less "effectual demand" to use Adam Smith's precise term.If in Lola's capitalist world prices are always going down then wages will go down but land values will remain sticky while interest rates will bottom out leading to land price inflation.Pretty much what is happening at the moment and we all know we are living in the best of all possible worlds !

Bayard said...

"wages will go down but land values will remain sticky while interest rates will bottom out leading to land price inflation"

How do you reach that conclusion? Lower wages => lower buying power => lower land prices. Land prices can only go up if the buying power decreases less fast than the interest rate, which is very unlikely, seeing that interest rates are almost zero already. as well as that, by making historic debt more expensive to service, deflation should reduce buying power except for new entrants to the market.
In any case, monetary inflation/deflation on its own has no effect on absolute land prices, it just affects how many units of currency you pay for the land, not how long the average worker has to work to pay for the average house.

Robin Smith said...

Lola: Bailout.

Robin Smith said...

DBC What do you mean when you say "wages go down as well"?

Do you mean the value of wages or the value of money?

Or do you mean the price of wages or the price of money.

Funny about France right now. The nation is fully in the grip of its own hysteria. The islamic freedom fighters are brilliant strategists. Their plan playing out perfectly.

Lola said...

I really do not agree about your 'reaching peak technology' thingy. What about autonomous vehicles? Point is no-one knows what some other entrepreneur will be able to conceive to delight us all / make our lives easier / have fun with. That's the beauty of capitalism. It's unplanned, simultaneously chaotic and wonderfully organised and hugely creative.

Robin Smith said...

Lola. If that's your belief I'm ok with that. But it is just another ideological/religious belief. Terrorists have them too. Glad to see youve got your energy back.

The Stigler said...

Mark,

This stuff does improve, but technology often goes through a process where someone invents a new thing that causes a dramatic leap forward, followed by lots of people seeing potential things they could do with it, and when other things happen, they improve it. Eventually, people run out of ideas (what else do you add to an iPhone) or it's hard to extract more out of something (why car MPG hardly improves now).

And for a lot of customers, something just gets to be good enough. A lot of people switched from VHS to DVD, but most people I know haven't made the shift to Blu-Ray. Even for me, as someone who loves big, epic films in Blu-ray, I go for the cheaper option for things like TV series.

Robin Smith said...

Stig: all improvements in technology end up in higher land values. Its LVT gospel.So any analysis of it is moot.

Has anyone recognised the archetypeople in La France - le bladerunner?

Random said...

I can't agree with you on this. A little bit of inflation is not harmful. The reason politicians (and everyone else) avoid deflation like the plague is it increases the real value of debts. There is a difference between deflation due to productivity gains and lack of demand.

Mark Wadsworth said...

R: "The reason politicians (and everyone else) avoid deflation like the plague is it increases the real value of debts."

Yes, that is the reason. So why do they come up with nonsense reasons about people deferring consumption?

Random said...

I agree Mark, all I am saying is it could result in a debt deflation spiral.

Mark Wadsworth said...

R, and I agree that a "debt deflation spiral" is exactly what the Home-Owner-Ists don't want. They want debts and land prices to keep increasing for ever.

If too many people are over-indebted, then deflation does become a problem.

But

a) Actually it's the debts which are the problem more than the deflation.

b) that is a completely different reason for worrying about deflation than the one I highlighted.

Bayard said...

"The reason politicians (and everyone else) avoid deflation like the plague is it increases the real value of debts"

and it makes land (house) prices go down, which is the political unforgivable sin. (it doesn't matter that they aren't going down in real terms, just that the number after the pound sign is decreasing).