Hacker News Reader

Comment by cs702 | Hacker News Reader

A persistently deflationary economy would be horrible:

When everyone expects prices to fall in the future, everyone becomes less willing to spend today. Sitting on cash becomes an investment with a positive yield. The less everyone wants to spend on goods and services, the less businesses sell of everything, and the more they have to compete by lowering prices further, making everyone less willing to spend... a vicious circle of economic contraction.

Businesses normally find it very, very difficult to cut employee compensation in line with declining prices, so they end up cutting costs by firing people instead, making everyone less willing to spend, so businesses sell less of everything, forcing them to cut costs futher... contributing to the vicious circle of economic contraction.

A deflationary economy is a negative-sum game in which everyone loses.

View on HN

This is the standard story about deflation, but the idea that a slightly deflationary environment will suddenly change purchase behavior has always struck me as a bit academic. The average consumer doesn't buy stuff because they think inflation is going to cause it to become more expensive in the future, they buy stuff because they need it. It seems borderline absurd to suggest that consumers are going to reconsider buying something because in a year it will be a few % cheaper in price.

However, I do agree that a persistent deflationary economy (and the corresponding expectations that it will continue) will have... interesting effects on interest rates, debt, and corporate spending. But I still am not sold on the idea that it's a de facto negative thing. I think saying "deflation = bad" oversimplifies the lessons to be learned from the Great Depression but unfortunately that's the lesson we're taught.

Of course it won't change consumer behavior for everyone all the time. At some point I'm just gonna have to buy that dishwasher. But it will change consumer behavior at the margin and what happens at the margin is what economic thinking is all about.

Also, it's not just about consumer behavior but also investor behavior. Why should I take the risk of investing my money in a new product or company if I can earn a profit by hiding my money under my mattress?

On your former point I actually agree, but that's not the way the 'deflation = bad' argument is usually presented. It's usually presented that "people will defer purchases", full stop, and that would be terrible but it's hard to believe. I agree it will happen on the margins, but that might not be a huge deal.

Investment wise, it always comes down to risk and inflation adjusted returns. Hiding your money under your mattress results in a risk free positive real return in a deflationary environment, but this just the same as buying a short term treasury bond.

It's self evident that just because you can get a risk free positive return, it doesn't mean capital won't take on risk for a higher one. If that were the case, nobody would invest in anything other than government bonds.

Deflation shifts the returns, making holding cash more attractive, so it reduces investment. Reduced investment likely results in lower long term growth as less new businesses and ideas can be funded.

Deflation effectively increases the risk free real rate. So the same effect of seeing the rate on the 10yr rise will be seen with disinflation. The difference being that you get some yield for "free" by just holding the cash and not buying bonds, but this is just incidental. The effect on risk-taking should be the same. So the point is I don't understand why it's treated as a deathblow for investment when we accept interest rate rises all the time without widespread panic about investment coming to a halt.

Cash you spend on buying bonds is actually being put to use by someone. Cash you stuff under your proverbial mattress isn't.

There is a huge difference between interest rate changes, which are set in large part by the Fed, versus deflation, which is not set by the Fed.

The return on a 10yr (govt bond I assume?) is set by the market - this is not just picked or changed arbitrarily, although returns there are likely influenced by Fed rates.

People control the interest yield for many products through the Fed, so we can avoid a deflationary spiral just by having the Fed change the interbank loan rate (among other things they can do).

Deflation (caused by many types of things from demand shocks to economic fears to war) is often not easily dialed back, and can lead to a deflationary spiral, which cannot be simply tuned by the Fed.

This is the reason the Fed targets slight inflation instead of zero inflation; the controls are not magic and the inflation/deflation tends to hover around where the Fed targets, and by staying away from zero we avoid possibly triggering a deflationary spiral we cannot control.

In short, we have good tools for dealing with inflation. We do not have equivalently good tools for dealing with deflation.

>When everyone expects prices to fall, everyone becomes less willing to spend

I find that contradictory. If something becomes cheaper, I will be more likely to buy it. It's the entire reason to have discounts and sales.

Slippery slope fallacy?

Sure it's cheaper, but if you wait another month it will be even more cheap. The longer you can hold of spending, the more you get for your money. Contrast that to a sale. During the sale, things are cheap now with the expectation they'll be more expensive later. Holding on to your money is now costing you buying power.

By that logic why do people buy iPhones? They can wait another year and get the same model cheaper or get a much better one for the same price.

The iPhone 6 just had record sales so empirically there are other factors for consumer purchases that are stronger than the "waiting for items to be cheaper" factor.

It is a fallacy because most consumption can only be postponed for an indefinite amount of time. If I need a fridge because my old one is broken or I just moved house, then I need a fridge. I'm not going to go without for 6 months because I think fridges will be cheaper then. We all purchase phones, computers, cars and sofas knowing that, in x months time, it's likely that the same item will be cheaper or same price but with more features.

It is true that major investments like new factories might conceivably become cheaper but this also ignores opportunity cost - in the same way, with inflation, new factories are more likely to become more expensive, so it's logical to think that in inflationary times, the countryside will be dotted with idle factories built as a hedge. This doesn't happen because of a variety of factors, not the least of which is that people make investments because they expect to see a big margin difference between keeping the cash and having that investment make cash for them. You don't built a new factory because you think you'll make 3% more than bank interest, you do it because you think you'll make 20-50% return on the cash.

The deflationary spiral postponed purchases explanation is a bit like the efficient market hypotheses - plausible sounding but ultimately and empirically not true in practice.

Reply on news.ycombinator.com