Posted: Apr 08, 2013 2:22 am
jamest wrote:Ihavenofingerprints wrote:jamest wrote:What are the pros and cons of deflation? And exactly when does deflation become a problem that needs resolving?
Deflation is simply the price of goods in the economy going downwards year to year.
So if prices are going downwards, there is less demand for products. Or there is too much supply.
Can deflation not have the opposite effect? I mean, if consumers see that products are coming down in price, do they not think "let's buy X before its price goes up again"? Or do they just hang on, absurdly waiting for the price of X to approach zero?
I think it depends on their expectations of the future price level. However if they expect that the fall in prices is going to be short lived it would open the opportunity for arbitrage and if people started increasing their consumption it would start pushing prices back up.
I guess there are precedents to confirm what you say, not least in Japan, but the situation seems rather odd to me - people refusing to spend their money until products become more expensive.
I would add that think about the effects of debt in the short/medium run. You have a house on a 30 year mortgage at 6% nominal interest rate with 2% inflation. That means the real rate of interest is 4%. If inflation falls to -2% now you have a 8% real interest rate.
Your mortgage amount is fixed so as each dollar becomes worth more your mortgage becomes effectively more difficult to pay off. For businesses they see falling revenue so they are going to require falling labor costs as well.