Topic: Is deflation truly that bad for an economy? - page 3. (Read 24916 times)

Because in deflation ALL prices fall -- including wages.  People hold off consumption because they don't have money to spend or is unsure about future income??

Keynes puts more emphasis on stimulus spending.  Lowering interest by itself without govt spending is not really what Keynes is about since he was more into trying to get back into full employment.  Sorry I'm wrong about monetarism.  Its more like the left mainstream economists like Lucas, Krugman, or Summers.  These guys would be labelled as a Neo-Keynesian, which most Old Keynesian or Post Keynesian don't consider in the spirit of Keynes.  IMO they have more in common w monetarists -- for instance being proponents of QE

10% inflation doesn't mean 10% growth (and I'm very doubtful about deflation as well). I'm not interested in you setting your variables as you see most appropriate to fit your assumption. I'm obviously more interested in what happens in reality.

And in fact, you logic is not consistent per se, as is shown in my question above.

I think some reality check is urgently needed. You insist that deflation mirrors inflation, and I take crazy numbers for an example. Okay, you have 3% inflation and a real interest rate of 2%, not something that you would call crazy, right? What will the real interest rate then be for the deflation of the same 3% according to your logic?

Because we are investigating the effect of inflation and deflation ALL ELSE EQUAL.  
I tried to explain why the real interest rate is the real market price of the money loan market: it is the tension between offer and demand of BORROWING VALUE.  If you borrow money (demand of loan), you are going to look at your REAL burden of the loan, and hence you will work with the *real* interest rate to see if you want to borrow or not.  I hope you will agree that, say, to buy a car or a house, if you have an inflation of 5% and the loan is 8%, or if there is no inflation and the loan is 3%, you will consider its burden the same, and whether you will demand a loan or not will be decided the same in both cases.
So you see that the demand curve in the loan market will depend on the real interest rate as the "price level of loan".
In the same way, you can argue that in order to lend out money, you are going to want a REAL return on your money, and for similar reasons, the offer curve in the loan market will also depend on the real interest rate as the "price level of loan".
So they will cross at a given REAL interest rate, which is the market price setting in the loan market.

The true price in the loan market is the real interest rate, that's my whole point.

Now, why don't you seem to see this in reality ?  Simply, because when we have actual deflation, or when we have inflation, the economic situation is different, prices are different and so on.  You cannot compare the current economic situation (where there might be some slight deflation) to the economic situation in the 70ies when there was huge inflation.  So you shouldn't be surprised that the real interest rate is also fluctuating in periods of deflation as compared to other periods of inflation.

But to take your example: if there would be a steady-state long term deflation of 10%, that would mean that we have a HUGE economic growth of at least 10%.  In such a booming economy, the real interest rate would most certainly be more than 10%, because the AVERAGE economic growth would already be 10%.  

Now, if the AVERAGE economic growth would already be 10%, independent of any deflation or inflation, every person in his right mind would never lend out any money for less than 10% (with a certain risk) in real terms.  Because he could get that same return by buying a basket of shares that is "the average economy" which would carry much less risk than lending out to a specific person for a specific investment.  

So yes, if the economic growth is a steady long-term 10%, interest rates would be at least 10% in real terms.
Also in your inflationary example.  

Suppose that you would have a crazy central bank that targets 10% inflation, and that the economic growth is 10% steady state (remember "all else equal" so also economic growth).  Then yes, people will want 10% return in real terms on loans, which comes down to a crazy 20% nominal rate.

But that's again, because you take crazy numbers.

And they are not so off the mark in fact.  I remember in the beginning of the 80ies to having had savings accounts with a return of 14% for instance.

Of course that the lowering of the i-phone 5 price when the i-phone 6 comes out, has nothing to do with deflation, this is as clear to me as to you.

But the ARGUMENT you (and so many others) use against deflation is that the diminishing of prices make consumers delay their consumption.   That *argument* against deflation doesn't assume deflation or anything, but makes the assumption that if a consumer desires item X, and knows that the price of item X will be 2% lower next year than today, he will delay the acquisition of item X to next year.  The *reason* why that price is lowering for that hypothesis is not specified.  It is (erroneously) assumed that if desired-for items will lower in price, consumers will delay their acquisition to profit from the lower price.

And THAT hypothesis is contradicted by the i-phone example.

Because if it were true, people that KNOW that their desired-for i-phone 5 which costs them, say, $500 today, that exact same i-phone, will cost maybe only $380 when the i-phone 6 will come out next year, and will wait for it, to profit from the price drop.

So if that hypothesis were to hold, i-phone 5 would only massively be bought when the i-phone 6 would come out, because consumers would have delayed their acquisition to profit from the price drop (which, in this case, we all agree, has nothing to do with deflation, but is a price drop all the same).


Lowering interest to counter deflation is monetarism.  Lowering interest rates to try to stimulate the economy, on the other hand, I thought, was pure Keynesianism.

Your actual burden will be equal to real interest rate. This I don't argue with, but you again miss the whole point. Why in the first place you assume that in real life you will have the real interest rate the same for both inflation and deflation? In 10% deflation the real interest rate will necessarily be equal to or more than 10% (by definition, since nominal interest rate is always above 0). But this in no case means that in 10% inflation it should be the same 10% (which would amount to 20% nominal interest rate, if rates are taken as percentage points). I obviously cannot accept your allegation as being relevant to reality.

In fact, you say that deflation mirrors inflation and then contrive arguments that fit your assumption. That won't work, unless you somehow manage to prove that the inflation real interest rate necessarily follows that of deflation.

Like austerity worked so well for Europe.

Stop bringing up iphones.  That has nothing to do w deflation

Lowering interest is not Keynesian its monetarism

It nevertheless is.  If you ask for an example where the nominal interest comes out negative, then it is your assumptions in the example that are wrong, that's all.

If you ask me to assume that the earth has a negative mass, and then using Newton's gravity, I have to conclude that the moon will not remain in orbit around the earth, you will say that my explanation is confused.   But that crazy example doesn't prove Newton's theory wrong of course.




Yes.  I don't see how you cannot see that elementary point.
We only have to assume that in the example, all nominal interests remain positive (simply because it doesn't make sense to have them negative).

So let us consider, again, a symmetric situation of 2% inflation, 0% inflation, and 2% deflation.

Let us start with the deflation case. Consider a positive nominal interest rate of, say, 1%.  We have to assume this.  But as I showed, this is also normal, because the mechanism that generates long term steady state deflation (namely, economic growth) also generates real interest rate (the increase in real buying power of capital).  If the nominal interest rate is 1%, then the real interest rate is 3% in our case.

Now, this is a genuine economic factor.  It gives you the genuine return in the loan market.  This is not something monetary.  The real interest rate is the real price of borrowing VALUE which is the essence of the loan market.

So if we assume all else equal in the economy, except for monetary inflation or deflation, we have to keep this REAL interest rate constant, which is 3%.

So in 2% deflation (say, because there is fixed supply money, gold or something) environment, the nominal interest rate will be 1%.

In a 0% inflation environment (say, the "ideal reserve" of our friend chicagoschooler) the real and the nominal interest rate coincide, so the nominal interest rate will be 3%.

And finally, in a 2% inflation environment (say, a Keynesian inspired monetary policy) the nominal interest rate will be 3% (real) + 2% (inflation) = 5%.

So we have, all else equal:

a loan at 1% in a 2% deflation environment
a loan at 3% in a 0% inflation environment
a loan at 5% in a 2% inflation environment.

These 3 give identical burdens.

Deflation means, less amount of money than the amount of goods and services and inflation means more amount of money than the amount of goods and services. Both are bad. To avoiding them you need calculating money supply by this formula: M = PQ/V.

That was to show the absurdity of your ideas (i.e. deflation being the mirror of inflation).


It just means that in deflation debt will most likely be more burdensome (the higher the deflation), since nominal interest rate will always be over 0 (whatever deflation rates might be). You are still arguing your primarily point?

When I use "we" I mean often "I".

I'm terribly sorry that the mathematics was beyond you

The negative nominal interest resulted from YOUR artificially demanded example.  
The very first example I gave was perfectly OK.  Then you insisted on me applying the same rules to examples of which YOU specified the (impossible) conditions.

Of course nominal interest cannot get negative.  It won't.  That doesn't mean that the real interest doesn't exist, and that there is no compensation for deflation or inflation.

As I explained to you:

Let us define growth G, real interest R, nominal interest N, deflation D, and inflation I.

1) real interest will be of the order of economic growth (plus risk) at least

R ~ or > G

2) nominal interest is real interest, corrected for inflation (added) or deflation (subtracted)

N = R + I in the case of inflation, or N = R - D in the case of deflation.

3) under sound money (fixed supply), deflation is equal to economic growth (and hence of the order of real interest).

D ~ G

As such, under sound money, nominal interest will not be negative:

N = R - D which leads to N > or ~ G - D and because D ~ G, we have that N > or ~ 0.

QED.

Stop speaking for us. Personally, I saw that you got confused between your own ideas. In deflation (or whatever) no one will charge negative interest rate for loans, whether real or nominal. You may build any theories, but this simple fact will leave no stone of them in practice.

You might hope you have an idea of what to expect !  If you have no idea whether the money you borrow has any chance of giving an ROI, then the interest on it should be huge, because the creditor takes a big risk of you defaulting !

And that's my point exactly: too cheap money (too low interest rates) invite people to be able to invest in low-return investments with no problem of default.  But, contrary to your claims, the capacity of production of capital goods is limited too.  So if many people can buy capital goods with very low return, because the credit conditions are easy, then most of the capital goods will be allocated to low-return undertakings.  And if most capital goods are allocated to low-return undertakings, well, global return in the economy (growth!) will be very low too.

This is what it means: easy money allows serious bad allocation of resources, while the investor doing so has no problems, and is not eliminated from the race.

It is here where we get the Keynesian recipe for disaster: if the economy slows down, Keynesians lower credit rates, which will cause even more bad allocation of resources, which will in its turn generate an even worse growth.  As a result, Keynesians lower even further the interest rate, until they are caught in the liquidity trap and/or stagflation.


Aggregate demand ORIENTS production. But if production is badly organized, because of mis allocation of resources, which is itself a result of cheap credit, it will not provide growth.


This is already 100 times that this has been contradicted.  Steady, minor inflation, or deflation, have of course not the slightest influence on consumption.  First of all because the effect is too small in the balance of things that make a decision to buy or not.  If you are hungry, the fact that next year a loaf of bread cost 2% more or less will absolutely not influence your decision to buy it right now.
And second, because it is compensated.  If you consider buying a sports car right now, or next year, you might say that next year, it will cost maybe 2% more, but you will also earn 2% more.  So the fact that it will cost 2% more next year, will not be the reason why you buy it right now or not.
And we already saw that everything that happens on credit is perfectly compensated because of the difference between real and nominal interest rate: in an inflationary economy, interest rates will be higher exactly by the amount of steady inflation.

This on the theoretical side.

On the empirical side, the examples with computers and i-phones show you that people do not delay their acquisitions because the price of the item will be lower next year ; and the price drop of i-phones is way way bigger than the price drop in a mild deflation.

In other words, as well empirically, as theoretically, mild, steady inflation or deflation have absolutely no influence on consumption.

The historical correlations that one finds have most probably the opposite causal effect: when economy slows down, credit contracts, people consume less, and HENCE prices drop.  So observed deflation is a consequence of economic slowing down, it is not its origin.
And when economy booms, there is credit expansion, people consume more, and HENCE prices rise, so there is most probably some inflation.  But these are consequences, not the causes.

With credit comes risk.  You can always default on debt, and dying is a way of defaulting on personal debt.
Debt is not an absolute moral duty or something of the kind.   In fact, one of the important things in business is that credit risk can be materialised without people being sold as slaves or something of that kind: it is called defaulting.
When there is a default, the creditor looses his money.  And that was part of his risk.  This is why a creditor bears a part of the responsibility of loosing his money.  But of course, defaulting shouldn't be too easy either.  You should have done everything which is reasonable to avoid default.  You shouldn't gain any advantage in defaulting.
But one of the most important "inventions" in doing business is the limited responsability.  A share holder can loose all of his share value, but cannot go negative.  If you are a share holder of a business, and that business goes broke, as a share holder, you do not get the burden of the debt.

Because an absolute burden of debt is unbearable.  The creditor should take part of the risk.  By allowing to default (and not transmit the debt on the back of the share holders) you make the creditor assume also his risk.


You might read David Graeber's book: "debt, the first 5000 years".
I'm not 100% in agreement with his positions, but his book is fascinating nevertheless.

In fact there are two kinds of "debt", and only one is really debt, and the other is just another name for extortion.

To me, a genuine debt can only result from a freely taken contract: the debt is "your part of the duty in the contract you agreed freely upon".

If we agree that you give me a hair cut today, and I will mow your lawn next week, then during a week, I have a debt with you, because you did cut my hair, and I still have to do my part of the contract: mowing your lawn.

But if some or other authority inflicts a debt onto you, that's nothing else but a form of extortion, formulated as if it were a debt.  If I say: "I, Lord of you, will give you protection, and you owe me a compensation for that protection", then that can be formulated as if you had a debt with me, and most of the debts in Graeber's book are of this kind, but it is nothing else but a delayed form of extortion by force.

Also, from what I say, it follows that debt cannot be herited.  Debt goes into default at latest when the debtor dies.  Because the children didn't freely sign the contract.  So they cannot be held responsible for the debt. 

So, to me sound debt satisfies these two rules:
1) debt can only result as the effect of a freely taken contract by an individual or a business
2) the creditor must assume a risk of default

There is no "blood and honor" duty to pay back any debt.  If the terms of the agreed-upon risk are met, then the debtor defaults, and the creditor assumes the risk and looses his money.
And debt cannot be inherited.  There is no primordial debt.  Nobody can inflict debt upon you.

And this is where something goes seriously wrong with government debt.  Debt is inflicted upon its citizens.  And debt will be inherited.  It violates the two principles of sound debt.

When you die, the debt has to be paid off by your holdings. If there is a remaining debt, this has to be written off. That is not a magic money creation scheme in the aggregate, because someone is owed that money, and they will have to take a loss. Remember, whoever has lent out, a company, a bank, the state, there is always one or many individuals who will have to take the loss.

If someone, for instance the children, takes responsibility for all assets and debts, the debts are also inherited. This could be done to speed up the process of inheriting and make it cheaper, but they would not do that if their parents were underwater. So it only happens where there is debt the children did not know about.

Thats only in your spinned crazy fucking keynesian world. In the real world economic growth can be done without credit too.

Of course you need to get the government out of commerce ,and abolish all taxes and regulations and permits....

If you have to pay 25.000.000$ for a fucking license, obviously you will need credit for that...

You don't know if investments are good or bad until hindsight.  Whether people borrow money to start business or buy houses and cars.  It doesn't matter.  What matters is aggregate demand drives production and jobs. 

The problem w deflation is you don't have that driver.  Falling prices don't make people consume more.  The rate of consumption is based on their income and confidence on future earnings

The point is simply that credits that stand for capital, are good.  Credits that stand for consumption, are a burden on the future.
Nobody is saying that credit that is backed up by capital is bad, on the contrary.  As you say, that's the source of growth.  but a mountain of debt, not backed by capital, is a recipe for disaster. 

Normally, the interest rate on credit is the lower bound of ROI of capital.  Indeed, no person in his right mind is going to take a credit to invest in capital on which the expected ROI is lower than the interest on the credit.  As such, the interest rate for credit is approximately the ROI on capital, which is then by itself the economic growth.  The funny thing is that by setting artificially the interest rate to near-zero, you are inviting people to invest in capital with an ROI of near-zero.  You shouldn't be surprised then to get an economic growth of near-zero !

Being generous on the credit market has the perverse effect of allowing people to invest in low-ROI capital.  That low-ROI capital will then, well, generate low ROI, which will imply a low growth.  As a reaction to that, Keynesians will lower even more interest rate !
To invite people even more to do bad investments...

And then you put them in camps, exterminate them, and the world becomes a better place

In other words inequality.  And inequality goes to extreme, you have social unrest.