Krugman: Why Is Deflation Bad?

[Kurt_and_Hunter]

(edited for copyright purposes proud patriot Moderator Democratic Underground)

I posted an anti-deflation screed here and then went to read Krugman's blog and he had just posted this.

He says it better than I would, so I'll let him take over...


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August 2, 2010, 5:33 pm
Why Is Deflation Bad?

A number of readers have asked me to explain why deflation is a bad thing; and the truth is that while I’ve alluded to the issue a number of times, I’m not sure if I’ve ever laid out the whole case. So here goes.

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield – Japanese bank deposits are a really good deal compared with those in America — and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed. If the economy is doing well, all this can be offset by just keeping interest rates low; but if the economy isn’t doing well, even a zero rate may not be low enough to achieve full employment.

And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.

http://krugman.blogs.nytimes.com/2010/08/02/why-is-deflation-bad/

[Common Sense Party]

1. Wages ARE prices, so, yes, they will fall in a deflationary period

[DJ13]

2. in a deflationary economy, wages as well as prices often have to fall

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Which is one of the bigger reasons the TPTB dont want deflation, as it could erode the huge profit gains from satgnant wages the corporations have obtained for themselves over the last 30 years.

In other words, the workers might regain some of their lost buying power.

[Kurt_and_Hunter]

3. No, it's disastrous for workers

The point about downward wage rigidity doesn't mean relative incomes improve.

It just means that reducing wages is brittle... There is a natural resistance to telling everyone they are now getting paid less money. (It provokes riots.) So when you cannot afford workers pressure builds until you eventually lay some people off. (And rehire someone at a lower wage, if need be.)

The downward pressure on wages becomes expressed in the unemployment rate.

All or nothing. Pay nine people and fire one works out the same as pay ten people 10% less.

If you are one of the lucky employed deflation is fun. (People with very steady jobs did great in the Depression.)

And concentrating the misery among the unemployed does a handy job of turning the employed against the unemployed.

If everyone got a wage cut we would have a revolution.

[DJ13]

4. I agree with you, but you're talking worst case scenario

Im talking about a mild deflation of short term duration.

Our modern Fed/Treasury has more than enough tools to limit deflation, provided they stop putting the concerns of the stock market ahead of the economy.

I think it boils down a need to re-balance the entire economy, and a mild short term bout of deflation might actually be a good thing in the long run.

[Kurt_and_Hunter]

5. ???

"mild deflation of short term duration"

That is essentially what we have had for the last two years and it's not helping anyone.

"Our modern Fed/Treasury has more than enough tools to limit deflation"

On what evidence? The Fed has had a base inflation target of 2% for two years now and hes not been able to achieve it, despite creating more money than anyone has ever heard of.

Japan doubled her monetary base between 1995-2002 while being in deflation. The Great Depression lasted forever and it took some very tragic demand-creation (WWII) to get past it.

Central banks have a hard time with deflation.

A welfare state government has an easier time because it can give money to people directly with no requirement of repayment.

But I'm not seeing a big push for retaining the census workers for the new task of handing out twenties on street corners.

[DJ13]

6. I dont see that we've had deflation "for the last two years"

Do you ever shop for groceries, or buy gas?

True, prices have remained steady in many cases, but portions have decreased at the same time.

(Try and find a half gallon of ice cream)

What I see is stealth inflation, which is why I cautioned in another thread about getting what you wish for and ending up with more commodity inflation that the government refuses to count in their official inflation figures.

[Kurt_and_Hunter]

7. Conversation ended with the "economic argument by anecdote"

The single largest class of investment in the US (residential real estate) has shed at least 40% of its price in 3-4 years.

The fact that ice-cream is higher notwithstanding.

[DJ13]

8. Equations make for lousy pictures of whats really happening

We dont live in a world of statistics, and the best interpretation of the real world comes from living in it.

[Kurt_and_Hunter]

9. Sorry I am being so rude today.

Just in a state I guess.

Without the snark, though, in economics the statistics are indispensable as the best picture of reality.

I live in one of the few areas where housing has held up okay and unemployment is low. (Washington DC) Most people I know are doing well.

But things like the CPI, GDP and unemployment rate tell us things not person can know from their experiences.

I know that when those statistics do certain things very bad stuff happens, even if things might seem okay to me.

There is a broad sense out there that inflation exists because a small number of ubiquitous consumer commodities have gone up for reasons having nothing to do with the broader economy. Gas, milk and cigarettes are things a lot of people buy several times a week. A house is something people buy every few decades, if at all.

So the things are felt quite differently.

And if a person cannot afford gas or milk they are really in a fix. What we need today is always the most pressing.

But we really have not had any inflation, across the whole range of goods, in quite a while now.

[DJ13]

10. No problem, we actually agree more than we disagree

Sometimes just taking the other side lets off steam.

:evilgrin: