With governments around the world stacking stimulus package over stimulus package and printing zillions to spend their way out of the last crisis, a deflationary scenario would be a miracle. However, deflation is the new new thing. Newspapers, magazines and all kinds of economic experts cry out against the risk of deflation triggering a downward spiral in consumption that would drive our economy to stand still with dramatic social consequences. Both the Great Depression and the Japanese crisis of the nineties seem to confirm this threat but is deflation really so bad a thing?
Looking back to the first globalisation wave, from 1880 to 1914 deflation was the rule rather than the exception. This means that the building of the continental railway in the US, the boost in communications coming from the transatlantic telegraph and the trade increase caused by steamships all happened during a long deflation cycle. Is this how a standstill economy looks like?
The basic idea behind the deflationary threat is that falling prices negatively affect demand as consumers delay their buying decisions expecting a better deal in the future. How is it possible then that consumer electronics, a deflationary industry where falling prices follow any product launch, is one of the most dynamic areas of our economy. How come a deflationary industry is by and large the most innovative of them all?
Some mention its effect on debt as one of the worst consequences of deflation. As the value of money grows so does the value of existing debts. In fact the value of debt increases but most of this increase can be compensated with lower, or even negative, interest rates. At the end of the day, low inflation doesn’t reduce much of any debt when interest rates are at two, four or six points higher. Furthermore, it is excessive debt and the absence of any real savings backing this debt that caused this latest crisis. With deflation savings would grow, providing a healthy capital accumulation that can foster investments while avoiding the bubbly tensions we now know so well.
If growth, progress, dynamism and stability are possible in a deflationary context, how is it that deflation is the new villain in town?
14th February, 2009 a les 11:50
Evolution of inflation linked bonds in the last two weeks show that investors start swifting from a deflationary scenario to a inflationary one. From my point of view in a few years time we could experience double digit price increases.
I disagree with you regarding the benefits of a deflationary world. I understand that consumer electronics is one of the most dinamic sectors in the economy thanks to its huge gains of productivity, which allow it to keep reducing prices (or keep prices for better products). The real threat of deflation, as you say, is its negative effect on demmand. The period you describe in US is a good example to contradict this theory, however I believe that at that moment the economy was experiencing, again, huge productivity gains. The real example about how deflation affects the economy is no other than Japan.
24th February, 2009 a les 10:45
I couldn’t agree with you when afirm deflaction is compensated with negative interest rate. In a deflactionary scenario negative interest rate are nominal negative interes rates and this is absurd.
1st July, 2010 a les 6:41
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