tag:blogger.com,1999:blog-7820485130017459619.post2032909339747969448..comments2023-10-24T01:46:47.151-07:00Comments on CynicusEconomicus: The Deflation ScareUnknownnoreply@blogger.comBlogger29125tag:blogger.com,1999:blog-7820485130017459619.post-44221337450772698432009-08-06T22:00:14.165-07:002009-08-06T22:00:14.165-07:00@cynicus,
my point about price deflation was that...@cynicus,<br /><br />my point about price deflation was that the 'good' deflation caused by improvements in productivity (PCs etc) doesnt cause people to put off their purchases.so there is no downward spiral in demand. on the other hand if it is deflation caused by an erosion in the monetary base (say-the central bank sucks out money at a constant 0.5% a year) then people may find it very rational to put off purchases since prices will fall at a predictable rate. this clearly will cause demand to reduce. productivy led price decreases are much more unpredictable than that caused by a transparent central bank.( a mythical creature)<br /><br />so your example of falling PC prices not causing people to put off purchases is not a good one for the true effects of deflation(monetary)Dsylexichttps://www.blogger.com/profile/03882859273018168075noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-91724469138066899632009-08-06T16:59:27.143-07:002009-08-06T16:59:27.143-07:00Lord Sidcup
Many thanks for the link. I watched t...Lord Sidcup<br /><br />Many thanks for the link. I watched the video with interest. <br /><br />Yes, "information does not equal understanding" was exactly the point I was struggling towards, and your final sentence sums up my thoughts very neatly!Lemmingnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-38716144443712133102009-08-06T10:44:03.679-07:002009-08-06T10:44:03.679-07:00http://www.rand.org/pubs/conf_proceedings/CF264/#b...http://www.rand.org/pubs/conf_proceedings/CF264/#behaviorally_informed_financial_services_regulation<br /><br />Maybe sort of relevant to Lemmings points. RAND has these videos of talks relating behavioural economics to Financial Services Regulation (by Sendhil Mullainathan of Harvard). Mainly at the level of communications from corporations to individuals, but I think wider understandings can be extrapolated. The main point i got is that information does not equal understanding. Fully rational models of efficient markets are being exposed as wishful lunacy.Lord Sidcupnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-64170148888909411572009-08-06T06:09:45.883-07:002009-08-06T06:09:45.883-07:00Cynicus
thank you for your response and for clar...Cynicus <br /><br />thank you for your response and for clarifying the point that you do not defend the current banking and political structure. Perhaps you are right to seek to remove emotive terms from technical discussions, but in my eyes you just cant leave out the problems we have with the banking and political status quo as that is the crux of why we are where we are. Many people have benefitted to a large extent from the way this country is structured, and continue to do so whilst as a result, many more people slip into poverty through no fault of their own. For me, this issue is too large to be avoided.<br /><br />Also, I agree with your analysis when you say, in response to another anonymous reader, that this crisis is just getting started - governments may, to give them some scant credit, be doing an OK job of managing our decline, but the decline has barely started and will be felt for many years. In earlier essays of your own you do a very good job of explaining in laymans terms why this is the case, and readers would be well advised to revisit these tracts in your archive. I think the problem is partly due to the fact the massive west-east wealth transfer has been obscured by our governments and will continue to be obscured - i dont see any signs of mainstream media attempting to disseminate the actual facts on the ground into the mass conciousness - far easier to spin economic data into a green shoots storyAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-41800323839931724252009-08-06T01:32:46.625-07:002009-08-06T01:32:46.625-07:00Lemming:
Thanks for the comment. If you take a lo...Lemming:<br /><br />Thanks for the comment. If you take a look on the fixed fiat post, on the reform of finance part, you will find that the independent oversight is free market, but that I accept a little regulation of how information is distributed to ensure sufficient resource in the hands of independent rating type agencies. The system assures that they only act on behalf of investors only, and have the resource to be effective in their scrutiny.<br /><br />The interference is minimal and simply extends some protection to the information from ratings and monitoring agencies, and is just a method of ensure independent scrutiny and sufficient resource is brought to bear on the banks/financial organisations such that their activities might be understood by investors.<br /><br />It is the absolute minimum of interference. In this scenario, the asymmetry will disappear, and the 'ordinary punter' will be protected. It is just getting the resource into independent agencies, and resourcing them so that they can match the banks. <br /><br />Sorry, a rushed reply.Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-34049880306329822102009-08-06T00:30:51.911-07:002009-08-06T00:30:51.911-07:00"With regards to consumers and commercial ent...<i>"With regards to consumers and commercial entities, a system of well funded independent oversight would rectify such problems. When there is no information asymmetry, then such practices will see the light of day. This kind of practice survives because the so called 'financial advisors' are paid commission by the financial services companies. I have proposed dismantling such systems."</i><br /><br />Over the last few months I have learned well - perhaps too well - from this blog that most economic problems can be explained by distortions of free market mechanisms. So why should the relationship between businesses and consumers require "independent oversight"? Why doesn't the Invisible Hand punish bad business practice? <br /><br />Perhaps if we substitute "expertise asymmetry" for "information asymmetry" we can see why: the ordinary punter doesn't stand a chance against the financial institutions. He will be suckered in regardless of how free and open the exchange of information is.Lemmingnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-4679085627365776462009-08-05T22:04:15.084-07:002009-08-05T22:04:15.084-07:00Correction: Money does not rise in value when you ...<b>Correction: Money does not rise in value when you move from High Inflation to Low Inflation 2</b><br /><br />From Wikipedia:<br /><br /><i>Deflation is a sustained decrease in the general price level <b>resulting in a sustained increase in the real value of money and other monetary items. Money and other monetary items are worth more all the time during deflation as opposed to being worth less all the time during inflation. Deflation is negative inflation.</b><br />Disinflation is lower inflation. <b>Prices are still rising during disinflation, but at a lower rate. The general price level still rises, but at a slower rate resulting in a continued, but lower rate of real value destruction in money and other monetary items.</b> A lowering of inflation is not deflation but disinflation.<br />Deflation means the general price level is not increasing at all, but, actually decreasing continuously and the internal functional currency – money - and other monetary items are worth more all the time. Deflation causes an increase in the real value of money and other monetary items.<br /><b>Inflation destroys real value in money. Disinflation destroys real value in money more slowly. Deflation creates real value in money.</b></i><br /><br />http://en.wikipedia.org/wiki/Disinflation<br /><br />The debt deflation effect we are talking about is when you <b>pay back your loan in money of greater value due to deflation.</b> (But of course paying higher real interest rates is also a part of the problem under deflation as well and to this extent the too situations are similar.)<br /><br />But even under disinflation (the move from higher inflation to lower inflation) the value of money is still falling, because it is only the rate of inflation that has changed.<br /><br />You are paying back your loan at a higher real interest rate, but the specific debt deflationary effect we are talking about here is different from paying a higher real rate of interest: it requires that the value of money has fallen through actual deflation.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-6496731748104425842009-08-05T22:03:07.529-07:002009-08-05T22:03:07.529-07:00Correction: Money does not rise in value when you ...<b>Correction: Money does not rise in value when you move from High Inflation to Low Inflation 1</b><br /><br />The specific effect of debt-deflation you are talking about here is <b>when money rises in value through deflation.</b> That is, if you pay back loans in money of higher value later (when it can purchase more) you are experiencing the specific aspect of debt deflation I was talking about.<br /><br />You say:<br /><br /><i>A good example of this can be seen in private mortgages on housing. If a loan is taken out in a high inflation environment, the interest rate will be relatively high. The targeted central bank interest rate will be high, and the lenders will seek to account for the high inflation by charging a rate of interest that will overcome the devaluation of the money that they are lending, such that they can achieve a positive return. If the interest rate is fixed over a period of, for example, five years and at year four the rate of inflation has fallen by a half, the holder of the debt is effectively seeing the value of their debt inflating. The earlier rate of inflation was eroding the value of their overall debt, and this was accounted for in the interest rate. However, with inflation falling, their debt value is no longer declining at the same high rate, but they are still servicing the debt as if this were the case. Their payments in relation to the actual value of the debt have increased.</i><br /><br />No, they are only paying a <b>higher real interest rate,</b> assuming that actual deflation does not occur.<br /><br />You can calculate the effect of higher real interest rates in this example here:<br /><br />In 2000, a business takes out a loan for five years at a 15% interest rate when inflation is 10% and the bank thinks it will stay at around 10% for some years. The real interest rate in 2000 is 5%. But the inflation falls to 5% by 2003. The real interest rate has risen to 10%.<br /><br /><br />NIR = nominal interest rate<br />I = inflation rate<br />RIR = real interest rate.<br /><br />year NIR I RIR<br />2000 15% 10% 5%<br />2001 15% 10% 5%<br />2002 15% 9% 6%<br />2003 15% 5% 10%<br />2004 15% 5% 10%<br /><br />But this effect is different from paying the money back when it is of greater value through deflation.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-74796918922573140382009-08-05T18:05:29.202-07:002009-08-05T18:05:29.202-07:00The Economist's economic dictionary sums up th...The Economist's economic dictionary sums up the danger of a deflationary spiral very nicely:<br /><br /><i>Deflation is dangerous, however, more so even than inflation, when it reflects a sharp slump in DEMAND, excess CAPACITY and a shrinking MONEY SUPPLY, as in the Great DEPRESSION of the early 1930s. In the four years to 1933, American consumer prices fell by 25% and real GDP by 30%. Runaway deflation of this sort can be much more damaging than runaway inflation, because it creates a vicious spiral that is hard to escape. The expectation that prices will be lower tomorrow may encourage consumers to delay purchases, depressing demand and forcing FIRMS to cut prices by even more. Falling prices also inflate the real burden of DEBT (that is, increase real INTEREST rates) causing BANKRUPTCY and BANK failure. This makes deflation particularly dangerous for economies that have large amounts of corporate debt. Most serious of all, deflation can make MONETARY POLICY ineffective: nominal interest rates cannot be negative, so real rates can get stuck too high.</i><br /><br />You say:<br /><br /><i>More to the point, you have still not demonstrated why high to low inflation is different from low inflation to deflation. The idea of the deflationary spiral is unsupported in any way.</i><br /><br />The answer is this: <b>of course the change from high to low inflation can have the same effects</b>!<br /><br />But the crucial point is that <b>in the absence of<br /><br />(1) High debt levels before deflation<br />(2) An actual recession <br />(3) A contraction in the money supply<br />(4) Continued and severe unexpected deflation<br />(5) high unemployment<br /><br />continued lower inflation or actual deflation will not have the same effects.</b><br /><br />You seem to forget that it is the <b>interaction of these factors</b> that creates the deflationary spiral. As I have already conceded, deflation <b>by itself</b> may not necessarily be problematic.<br /><br />Nor is a limited period of disinflation, provided it stabilizes. <br /><br />In a booming economy <b>disinflation</b> (a fall in the rate of inflation or a <b>slower increase in prices but not an actual fall</b>) will not have the same effects as long-term, severe deflation in a recession where there is a large amount of debt.<br /><br />A change in the inflation rate from 3.5% to 2% over one year and then stable inflation at 2% in a booming economy with low debt and high employment will not be a serious problem.<br /><br />Many businesses would probably not even experience a fall in the prices of their products.<br /><br />The inflation fall might even be due to external factors like falls in the prices of imports of raw materials.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-88704669615612625812009-08-05T15:51:32.219-07:002009-08-05T15:51:32.219-07:00Anonymous:
Regarding what I am going to blog abou...Anonymous:<br /><br />Regarding what I am going to blog about now. It is nice to see your optimism. I beg to differ on the idea that the crisis is over. It is still in the early stages. If you have followed the blog, you will understand why. <br /><br />Dyslexic: <br /><br />I am not sure I follow your point. Would you like to clarify?Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-57124384996258939512009-08-05T15:46:30.162-07:002009-08-05T15:46:30.162-07:00Lemming and Anonymous:
I was aware that my defenc...Lemming and Anonymous:<br /><br />I was aware that my defence of banking would raise some hackles. However, I make no defence of the current system, in which government is in bed with the banking system. I made very clear that I do not accept the current cosy system, and in my money reform I propose a system which entirely dismantles such cosiness/corruption, and subjects the banks to scrutiny that removes the information asymmetry. Furthermore, I propose the dismantling of a system in which any bank becomes 'too big to fail' such that no bank can dominate any market. <br /><br />Yes, the current position of the banks is abysmal and is distorting the economy in favour of the banks. This does not detract from the principle that, in a system in which banks take **real** risk, there is a balance of risk on fixed interest rate contracts. Both sides must make their own assesment of the risk of inflation/deflation/interest rates, and the state of the broader economy.<br /><br />Lemming:<br /><br />You said the following:<br /><br />"I had to smile at the idea that banks and borrowers take equal risks! All the banks have to do is to insert some small print that allows them to set interest rate "collars" at their discretion, or similar devices. Recently various banks were found to have substituted their own "Bank X Base Rate" in place of "Bank of England Base Rate" in their tracker mortgage small print, which technically allowed them to ignore any falls in BoE interest rates as it suited them." <br /><br />With regards to consumers and commercial entities, a system of well funded independent oversight would rectify such problems. When there is no information asymmetry, then such practices will see the light of day. This kind of practice survives because the so called 'financial advisors' are paid commission by the financial services companies. I have proposed dismantling such systems. <br /><br />I have outlined how the banking system should work. I make absolutely no defence of the current corrupted system. However, banks in an environment of independent scrutiny, where they face the risks of their own losses, have an important function within an economy. The use of the term rentier suggests that banks do not earn their profits. At the moment, this may be true, which is why I make no defence of the current system. <br /><br />If working correctly, banks are a useful part of the economy that make a positive contribution. If you read Lord Keynes' statement and my response, I am simply pointing out that his use of the term is suggesting that banks are inherently a 'bad thing', which is simply banal. <br /><br />Having been one of the few people who has consistently argued against the bailouts of the banking system, from the moment the first bailout was proposed to now, having specifically said I am against the current system in my reply to Lord Keynes, I find it somewhat puzzling to see these comments. <br /><br />I am simply pointing out that banks are not inherently bad.Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-8871941155102391822009-08-05T13:23:54.351-07:002009-08-05T13:23:54.351-07:00Does the untidy ending of a 'bubble' - lik...Does the untidy ending of a 'bubble' - like the one we have recently experienced in housing - merely disguise the fact that a commodity essential to life *could*, in the right circumstances, end up being controlled by a 'rentier class' which basically holds the population to ransom? <br /><br />Do the usual rules of the free market apply when people have no choice but to pay whatever is demanded for, say, rent for a house, without which they would not be able to work at all? <br /> <br />Doesn't banking already have that feel about it..? And hasn't it always been so?<br /><br />(Sorry to be falling for the "emotive" and "populist" line of reasoning!)Lemmingnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-27634429040703941852009-08-05T13:11:15.211-07:002009-08-05T13:11:15.211-07:00Cynicus
You admonish a reader above, for using th...Cynicus<br /><br />You admonish a reader above, for using the term rentiers - an emotive and populist term, in your eyes.<br /><br />Where he using the term in an emotive and populist way to sway opinion - by no means certain - the views of many impartial and informed commentators, such as ex-IMF economists Simon Johnson and Joseph Stiglitz, imply that the practises of the financial industries in the USA and UK - primarily the banks - justify such criticism and even more besides; the picture is that of financial oligarchs with a death-grip on our economies through the capture of our corrupt (surely proven beyond doubt by the expenses scandal in the UK and various lobbying scandals in the US) political systems. For years, the argument goes, we have had privatized banking profits, yet as soon as the bad times come we socialize the losses. Taxpayers paid once for interest on mortgages and loans - and over-priced mortgages at that, as the banks expansion of credit chased up asset prices - then are paying all over again through raised taxes and reduced services, in order to bail out the very lenders who overcooked the credit expansion that got us in trouble!<br /><br />The one constant? The structure of the city, with minor alterations (no glass-steagall 2 for instance)and financial sector bonuses. <br /><br />Or is there anything in the above that you disagree with Cynicus - for if not, you must admit you were incorrect to admonish your reader, unless you had done so for not fastening on the term "parasitic" in front of the offending word.<br /><br />By the governments own figures, Inequality had risen at a fast rate throughout Blair and Browns debt-"boom"; the recession/depression/stagnation is finishing the job, turning us more than ever into a land of haves and have nots.<br /><br />Or do you disagree with that Cynicus? Or see something inherently good in it?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-31435495063485732662009-08-05T12:05:18.134-07:002009-08-05T12:05:18.134-07:00...in both cases, the person taking the loan has a...<i>...in both cases, the person taking the loan has an opportunity (in most circumstances) of fixed interest over varied periods of time, or floating interest rates. They make that choice, and assume the risk.<br />...You also forget that, in the reverse scenario, the bank loses out. From low inflation to high inflation they will lose in a fixed interest rate deal. The "rentiers" do not always get it right and sometimes make smaller profits, or lose money, as a result. Do you protest the unearned windfall falling upon the borrower at the expense of the bank? I think not....</i><br /><br />I had to smile at the idea that banks and borrowers take equal risks! All the banks have to do is to insert some small print that allows them to set interest rate "collars" at their discretion, or similar devices. Recently various banks were found to have substituted their own "Bank X Base Rate" in place of "Bank of England Base Rate" in their tracker mortgage small print, which technically allowed them to ignore any falls in BoE interest rates as it suited them. <br /><br />We are simply not talking about equally armed opponents here. I do not think many bankers would lose sleep over being called "rentiers" by us peasants.Lemmingnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-48077318173047409932009-08-05T11:58:15.316-07:002009-08-05T11:58:15.316-07:00i think there is a difference between the price de...i think there is a difference between the price deflation caused by productivity improvements -ie PCs and those caused by deflationary 'expectations'. productivity expectations cant be taken for granted but if a central bank is credible and announces a 5% deflation ,say, then there is every reason to believe that people will put off making purchases. my point is that the productivity improvements are much more volatile than monetary base decreases-which can be controlled by the central bankDsylexichttps://www.blogger.com/profile/03882859273018168075noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-69870751853010087202009-08-05T11:50:33.721-07:002009-08-05T11:50:33.721-07:00Things in the economy are quite obviously getting ...Things in the economy are quite obviously getting better. This is demonstrated by every major indicator. <br /><br />What most of the economic data is several weeks old, with more positive data most likely in the pipeline.................................. The <br /><br />The recession is coming to a close - Government policy worked - What are you going to blog about now?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-2084487986972036822009-08-04T23:11:58.676-07:002009-08-04T23:11:58.676-07:00Deflation Debate
For anyone who wants to read my ...<b>Deflation Debate</b><br /><br />For anyone who wants to read my longer response on the deflation debate, see my blog:<br /><br /><a rel="nofollow">http://socialdemocracy21stcentury.blogspot.com/</a><br /><br />A sample:<br /><br />When there is a depression or recession, and deflation occurs, there are reasons why deflation can cause deeper economic contractions. The crucial point is that, if there is a very high level of debt before a recession begins, then deflation can have devastating effects.<br /><br />Quite simply, Cynicus Economicus does not address the issue of profit and wage deflation, loss of consumer income, and the effects of continuing deflation.<br /><br />It is the interaction of factors caused by deflation in a recession that can lead to a self-reinforcing downward spiral of prices, profits and wages.<br /><br />The crucial factor is that the deflation continues.<br /><br />If prices fall, eventually profits fall as well, and employers must cut wages or reduce employment.<br /><br />Because of wage “stickiness,” businesses will often be forced to reduce employment, rather than reduce wages.<br /><br />Debtors will suffer when they become unemployed and have no income. <br /><br />Recessions can cause deflationary pressures. When demand falls and consumption falls sharply, first inflation falls through distress selling. If demand and consumption do not recover (or indeed become worse), this cost cutting caused by businesses reducing excess inventory will result in actual deflation. During this process unemployment rises and there will be downward pressure on wages. If there are steep cuts in wages, then incomes are reduced: this is the real cause of debt deflation: unemployment and cuts to wages. <br /><br />There is both empirical and theoretical evidence that large amounts of debt in an environment of unanticipated wage and price deflation has disastrous effects on economic activity (Zarnowitz 1992: 156; Caskey and Fazzari 1987).Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-16787768479713348602009-08-04T21:37:56.886-07:002009-08-04T21:37:56.886-07:00Continued from last comment....
You also forget t...Continued from last comment....<br /><br />You also forget that, in the reverse scenario, the bank loses out. From low inflation to high inflation they will lose in a fixed interest rate deal. The "rentiers" do not always get it right and sometimes make smaller profits, or lose money, as a result. Do you protest the unearned windfall falling upon the borrower at the expense of the bank? I think not....<br /><br />Overall, your argument is emotive and populist, only painting one side of risk. Both parties in any interest rate agreement take risks. If a business fixes interest and high inflation takes place it wins. If inflation falls, it loses. Likewise for the bank, but in reverse. <br /><br />You say:<br /><br />"Furthermore, in unregulated financial markets, the extra money of banks could just as easily be spent on creating asset bubbles, not productive investment."<br /><br />This is of no relevance to the issue of inflation and deflation. This is more rhetoric. <br /><br />The final point I would make is that whether moving from high inflation to low inflation, or low inflation to deflation, any business that puts itself in a position to be unable to manage the process is being poorly managed. Most businesses will see many changes to their revenue and costs over a period of time. Good businesses adapt to these changes, marginal businesses die. <br /><br />For example, a sudden inflation in oil prices hit the airlines recently. Their management of the process was different from airline to airline - as one would expect, and some airlines were in deep trouble, and others managed the effects without too much trouble. <br /><br />Whilst nobody wants instability (one of my core arguments is for stability), businesses do adapt....<br /><br />More to the point, you have still not demonstrated why high to low inflation is different from low inflation to deflation. The idea of the deflationary spiral is unsupported in any way. All businesses include expectations built on any number of scenarios, and change to scenarios might have a negative impact. That only deflation might have an impact just does not add up. <br /><br />I am sure you will respond again, as you always do, but I will leave the debate here. <br /><br />As a final note, nothing here is in any way a defence of the banks in the current system, in which state support is providing them with a win only option. However, in principle, there is nothing wrong with banks making money from taking the risk of lending money. The necessity is that the risk must be there.Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-73334841365439694472009-08-04T21:37:32.567-07:002009-08-04T21:37:32.567-07:00Lord Keynes:
You say that:
'This is far less...Lord Keynes:<br /><br />You say that:<br /><br />'This is far less likely if there is just a shift from high to low inflation.'<br /><br />But why.....? The impact upon the debt burden is identical. Asserting this does not make it true. Moving on....to another point...<br /><br />From the point of view of the renter, the fixed term of the lease will create a greater burden relative to turnover. However, in a move from high inflation to low inflation, the situation is identical. Over the term of the lease, the income over the term will decline relative to the rent. With less inflation their revenue will not be the same as high inflation. Moving from an expectation of revenue of 110 to 100 is the same as a move from 100 to 90. In both cases, the change is 10. One is expectations from high inflation to no inflation, and the other is from no inflation to deflation. <br /><br />If there is very high inflation expectations, the expectations will also be of ongoing high growth in revenues and this will feed into business planning. Likewise rents be set to account for high inflation over the term. If a renter expects inflation to be 20%, they will set their rent higher than if they expect 10%. In an inflationary environment rents will rise every year, and the higher the inflation, the higher the rise will be. <br /><br />The unexpected shift from high to low inflation will mean that expected growth in revenue will not take place. The failure to meet growth expectations might leave many businesses exposed, including on the ability to service the rent that they agreed at the start of the term. <br /><br />In both cases, rent will be set in considerations of an inflationary/deflationary environment, and any significant change will have negative consequences. <br /><br />You say:<br /><br />"But, when they do, there is no reason why real wages will not fall. If employment is cut and purchasing power is diminished, this will reduce demand even more, making a depression worse. We are back to the problem of a deflationary spiral."<br /><br />But why is employment cut? You are linking deflation to unemployment. Why? <br /><br />Deflation **might** lead to wage cuts, but that does not mean higher unemployment. You simply assume that deflation means high unemployment, and assume that deflation causes the unemployment. This is why I went to the trouble of detailing Smith's paper. To prevent people making these assumptions. <br /><br />You say:<br /><br />"Precisely, it disadvantages productive members of the community, to the advantage of rentiers."<br /><br />I do not like the term rentiers, as it has emotive connotations. I do not like the current situation of the banks, but do not think that the underlying function of banks is a bad thing. Allocating capital is not an act of evil or a 'bad thing' (provided that risk is not insured by the state so that there is no downside). Using the term rentiers is an emotive term. Why use it in this context, if it is not to sway through rhetoric rather than argument?<br /><br />Also, you would equally need to protest when the banks profit from a move from very high inflation to low inflation. In both cases the banks profit. <br /><br />Also, in both cases, the person taking the loan has an opportunity (in most circumstances) of fixed interest over varied periods of time, or floating interest rates. They make that choice, and assume the risk.Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-11847102932857671092009-08-04T20:58:58.484-07:002009-08-04T20:58:58.484-07:00The example of purchases on credit with interest o...<i>The example of purchases on credit with interest of goods and services suggests that there is a fundamental flaw in the deferred purchase argument; that theorists have misunderstood the psychology of consumers. Purchasing a product on credit at interest is a real increase in the cost that will be paid for the good, whilst saving the money with interest paid is a real decrease in the cost paid for the good. Despite this, many consumers do not defer the purchase, but instead choose to purchase the good at greater cost now, than the cost in the future. Furthermore, in sectors such as computers, the deflation of the good does not prevent purchases utilising credit.</i><br /><br />But again you ignore how consumers would behave in an environment of general, strong and sustained deflation in the CPI, not just of one product in a booming economy.<br /><br />If the consumers have lost their jobs or have seen wage cuts in a recession during general price deflation, then would they be so ready to purchase goods?Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-78738852663016922712009-08-04T19:14:42.572-07:002009-08-04T19:14:42.572-07:00Your scenario assumes that the cost of debt and re...<i>Your scenario assumes that the cost of debt and rent will remain static.</i><br /><br />But these are precisely the things that will be fixed in nominal terms by contracts, if deflation is unexpected. If the lease of a building is fixed for a year, the business is locked into a year contract of rent at a fixed rate. <br /><br /><i>In addition, wages can fall in absolute terms but still retain their purchsing power. If everything is falling in price, then the purchasing power of lower absolute wages remains the same as the higher wage.</i><br /><br />Yes, that was my point. Nominal wages will have to fall at some point.<br />But, when they do, there is no reason why real wages will not fall. If employment is cut and purchasing power is diminished, this will reduce demand even more, making a depression worse. We are back to the problem of a deflationary spiral.<br /><br /><i>Furthermore, the lender will have greater profits from the higher real rate. This profit will then be used for new investment at lower interest rates.</i><br /><br />Precisely, it disadvantages <b>productive members of the community,</b> to the advantage of rentiers.<br />Furthermore, in unregulated financial markets, the extra money of banks could just as easily be spent on creating asset bubbles, not productive investment.<br /><br /><i>Furthermore, as I pointed out in the article, would you argue against moving from high inflation to low inflation. The effect on debt is the same as a move from low inflation to deflation? It seems the argument against the alteration of debt burdens is only made when the word 'deflation' appears, and that is simply inconsistent and illogical. If the effect on the debt burden is the same in each case......???</i><br /><br />Moving from high to low inflation is not the same thing as deflation. The point is that sustained and severe deflation can lead to a deflationary spiral, <b>if there is a very high level of debt.</b> This is far less likely if there is just a shift from high to low inflation.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-72412309628750295642009-08-04T16:31:47.192-07:002009-08-04T16:31:47.192-07:00Lord Keynes: Thanks for adding the reference.
Re...Lord Keynes: Thanks for adding the reference. <br /><br />Regarding the devastation of the debt deflation, I am not sure that your example caputures what is going on. <br /><br />Your scenario assumes that the cost of debt and rent will remain static. If the interest rate is not fixed, this will not be the case. If there is a general deflation the cost of rent will also go down. Finally, the cost of the inputs for the manufacture of the clock will also go down. <br /><br />In addition, wages can fall in absolute terms but still retain their purchsing power. If everything is falling in price, then the purchasing power of lower absolute wages remains the same as the higher wage. <br /><br />In the event the interest rate is fixed, this will have a negative impact upon the company. However, it is the only impact, and will only last as long as the fix. Furthermore, the lender will have greater profits from the higher real rate. This profit will then be used for new investment at lower interest rates. <br /><br />The current crisis is one in which there is potential for deflation due to overcapacity in many industries, for example retail. This is resultant from the credit boom. Unless another new bubble can be formed, the overcapacity will still need to be removed, and this will cause unemployment. In these cases the deflation is simply a symptom, not the cause of an underlying problem. <br /><br />In the case of retail, for example, there are currently endless rounds of sales. There are just too many shops in relation to the spending power of consumers. This is pushing down prices, and still many shops can not achieve sufficient sales to survive. Only when the overcapacity is removed, will they be able to return to profit. <br /><br />Deflation is the symptom, not the cause. Changing the units of money in the economy can not remove the underlying problem of over capacity. <br /><br />Furthermore, as I pointed out in the article, would you argue against moving from high inflation to low inflation. The effect on debt is the same as a move from low inflation to deflation? It seems the argument against the alteration of debt burdens is only made when the word 'deflation' appears, and that is simply inconsistent and illogical. If the effect on the debt burden is the same in each case......???Markhttps://www.blogger.com/profile/14983165364072918091noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-70045020147236499502009-08-04T13:10:26.809-07:002009-08-04T13:10:26.809-07:00Cynicus,
Thanks for the reply. Will keep in touc...Cynicus,<br /><br />Thanks for the reply. Will keep in touch. I went digging through JStor for any related papers. They might be useful for a term assignment. <br /><br />Brian P.Brian Woodsnoreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-19730990121129100852009-08-04T03:29:03.990-07:002009-08-04T03:29:03.990-07:00You argue:
if wages were to remain static in mone...You argue:<br /><br /><i>if wages were to remain static in monetary unit terms during a period of steady deflation, … the person would, in real terms, see an increase in their wealth. Even if the person’s wage were to decrease in a period of deflation provided that the decrease is less than the rate of deflation, they would still be seeing an increase in their wealth. Why such outcome might be viewed as problematic is entirely unclear.</i><br /><br />The fatal flaw in this argument is that it fails to take account of the effects of debt and leases during unexpected deflationary periods. If nominal wages remain constant but prices of goods fall (and hence sales earnings), eventually this will cause profits to fall if companies have debt to service or rent to pay.<br /><br />Consider a factory that makes clocks. It manufactures 100 clocks a month, and the clocks sell for $1 each. Earnings are $100 dollars for the month. Wages are $80. Profit is $10, but payments for debt and rent are $10.<br /><br />This can be summarized here:<br /><br />Output 100<br />Sales $100<br />Wages $80<br />Profit $10<br />Debt payments and rent $10 <br /><br />However, the economy is hit by a recession and deflation occurs. Now the clocks only sell for $.90. Sales are only worth $90. But nominal wages are still costing $80.<br /><br />What has happened? It can be shown here:<br /><br />Output 100<br />Sales $90<br />Wages $80<br />Profit $0<br />Debt payments and rent $10 <br /><br />Profits are now zero, because debt and rent still have to be paid. Debt deflation has occurred.<br /><br />The company is going bankrupt, unless it slashes wages. <br /><br />Wages are not going to remain static in monetary unit terms during a period of steady deflation: they must go down at some point.<br /><br />Moreover, even if wages fall at a rate less than the deflation rate, rent and debt payments are unchanged, because they are set by contract.<br /><br />Debt deflation is real – and devastating.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.comtag:blogger.com,1999:blog-7820485130017459619.post-27081265516799528262009-08-03T22:16:58.103-07:002009-08-03T22:16:58.103-07:00I think the Gregor Smith reference is:
Smith, G. ...I think the Gregor Smith reference is:<br /><br />Smith, G. W. 2006. “The Spectre of Deflation: a Review of the Empirical Evidence,” <i>Canadian Journal of Economics</i> 39.4: 1041–1072.Lord Keyneshttps://www.blogger.com/profile/06556863604205200159noreply@blogger.com