Deflation danger is real. (Gas and food do not tell the story.)

[Kurt_and_Hunter]

Many folks are fearful of inflation and convinced that we have inflation because the prices of three key commodities are going up: Gas, food and health care. These happen to be things we all need and we are very sensitive to their prices.

It is indeed harder for us to get by because of these isolated commodity increases, but they are not indicitive of inflation in the broad economy. (That is why food and gas go up but there is no COLA for social security. This suggests a different way of figuring COLAs, but that's another topic.)

Inflation is a broad phenomenon in an economy. It.is the sum of all price/asset action. If you bought a tank of gas this week you paid a few dollars more. If you bought a house this week you paid 50, 100, 200 thousand dollars less. Nationally, all housing is down including rent. (Some rents go up in some areas but paces like Florida and Nevada are still part of America and the average price action is flat or down.)

And there is one thing you can buy that is definitely cheaper than it was: the labor of a human being. Most of us are on the worker side, not the employer side, so we do not see our flat or declining wages in terms of inflation/deflation. But the price of the commodity that we have to sell (our labor) is not skyrocketing!

In the big picture, the only picture that matters for things like national monetary policy, we are not experiencing inflation and are in ongoing danger of slipping into deflation.

Deflation is like jobs... we can have positive job growth while actually slipping further back because the economy needs to create about 150K jobs/month just to stay in the same place. Similarly, we can have effective deflation while nominal inflation is technically positive. Anything under 2% inflation represents slipping backward. (The Federal Reserve minimum inflation target is 2% and we are unable to hit it despite the Feds massive efforts to do so. And the Fed is normally a very anti-inflation institution.)

November 5, 2010, 12:00 pm
Wages And The Slide Toward Deflation
PAUL KRUGMAN

I get a fair number of comments to the effect that worries about deflation are all wrong, look at commodity prices. I’ve tried in the past to explain why we should focus on sluggish, sticky prices, not volatile prices like commodities — hence core inflation. But let me add another point: arguably the stickiest, sluggishiest prices are those of labor. So why not focus on wages?

There are, in practice, some problems with doing this, involving composition effects, overtime, etc.. But still, if you want another indicator of the big slide in underlying inflation, look at average hourly wages:



http://krugman.blogs.nytimes.com/2010/11/05/wages-and-the-slide-toward-deflation/

[Turbineguy]

1. Ahhhh..... so this is why

Boner will not take a pay cut. He's protecting us from the dreaded deflationary spiral.

[xchrom]

2. no one is going to listen.

just not going to happen.

until there is a french, greek, spanish style real movement -- we have already been box car-ed into our future.

[BootinUp]

3. Krugman is not a "serious person" therefore

turn on CNBC, or go to market watch or bloomberg or anyone but Krugman so you don't have to worry about this.

[enlightenment]

4. Okay. Trying to understand . . .

Inflation across the board is bad because it makes everything, including borrowing, more expensive?

Deflation is bad because lower prices lead to less production leading to lower wages?

As far as Mr or Ms Average Hourly Earnings, the end effect is the same - or at least so it seems. If things cost too much, a higher average wage isn't going to make much of a dent (inflation); if average wages are low, lower prices are still 'high' relative to earnings.

I know I'm completely off-track . . . may I plead stupidity and ask for a primer (or a link to a primer), please?

[Kurt_and_Hunter]

5. The system is designed for inflation

Say you buy a house for 100K. The total of payments you will make over time will be about 200K because of the interest.

But that's okay because you will be paying with smaller dollars -- dollars made less valuable by inflation.

So you are not really paying 200K *current* dollars.

If wages (and housing prices) do not go up, however, you are screwed. You will actually have to pay 200K *real* dollars for your 100K house, and you cannot sell it for any more than 100K.

For a generation we have been throttling inflation down because that's what banks want. And we have gotten flat wages out of the deal.

The political support for our bank-friendly policies comes from the fact that people perceive inflation as bad because we do not think of our wages as a commodity.

When the price of bread goes up we see inflation.

When we get a raise or a better job we see it as justice, not inflation. But for the person hiring us it is inflation of wages.

At some point the economy, which is designed to have constant inflation of about 2%, stalls. With no inflation borrowing money is a sucker-bet. That's why our "record low" mortgage rates are not able to support the housing market. Adjusted for inflation they are not record low rates at all! They are actually too high.

Inflation is neither good nor bad... it is necessary, but in moderation.

[enlightenment]

6. Thank you.

I appreciate the reply!

Still struggling with it, but I think I need a dummies' guide - with pictures (or another cup of coffee. Or both. Probably both).

Thanks again.

:yourock:

[BootinUp]

7. Inflation encourages investment/spending

thats the main advantage.

[Kurt_and_Hunter]

8. +1 (And repairs balance sheets)