mark9950

I just heard about it on the radio.

missus_gumby

Hi ho! Hi ho! It's off to MD we go!

Martin (Moderator)

Bookwyrm

I don't know that this is what the radio show was referring to, but I seem to remember that deflation is the term used in economics for an increase in the buying power of the dollar, or other unit of currency, the opposite of inflation. On the other hand its been a while since I took economics, so I may be misremembering this.

It also could be refering to a gradual decline in a "bubble" like the technology bubble, as opposed to a sudden bursting of the bubble, but this is even more speculative on my part as I've definitely never heard the word used in this way.

AquaVita

Erm, not to bounce this bad-boy around too much, but I think talks of economy and such should go to PD.

Chuck

Short answer: deflation is when consumer prices drop and there is less currency and credit available in the economy. Not a good thing.

Someone correct me if I remember incorrectly.

Chuck

boneyard bill

The term "deflation" originally meant a reduction in the supply of money in circulation just as the term "inflation" meant an increase in the supply of money in circulation. Later, inflation came to mean an increase in prices. i.e. the effect was given the same label as the cause.

While deflation has also been used at times to denote a general reduction in the level of prices, such a phenomenon is so rare these days that you don't usually hear it in that context.

It seems to occur more in the context of international exchange rates. When the dollar is strong there is an international dollar deflation in that there are fewer dollars in circulation relative to the major competing currencies such as the yen, the pound, the euro, the Swiss franc, and the international gold price.

Alonzo Fyfe

Deflation is a drop in the consumer price index, or, a drop in prices.

It is widely thought that this is what caused the major meltdown of the Japanese economy in the late 1980s and 1990. The overall reduction in price tends to include stock market prices, which reduces the amount of available capital, which in turn puts a damper on business investment and other activities that allow an economy to grow.

One of the relevant questions that economists ask in times of deflation is: Why are companies lowering their prices? They are doing so because they are unable to attract enough customers. Selling a product at a bit lower price is considered better than not selling it at a higher price. It is a period when corporations have no "pricing power". It means that businesses are under a great deal of economic stress, and for this reason they do not invest to grow. In fact, they are more likely to shut down parts of their industry than to invest in growth.

To give you an idea of how destruction deflation can be, over the past 18 years the average rate of return for investments in the Japanese economy has been negative. Somebody who started saving for their retirement in 1985 has seen the value of those investments continually diminish over time. He would have been better off stuffing his cash into a mattress somewhere than he was by investing it.

js_africanus

There is not much to add regarding the defn. of deflation. Just as inflation is a more-or-less permanent increase in the general price level, deflation is a more-or-less permanent decrease in the general price level.

This is "good" from the consumer's point of view, since prices go down. It is bad for the economy because it will tend to undermine investment. To understand this, think about inflation. If you have a dollar today and the price level goes up, then there is less stuff that you can buy with your dollar--a Coke used to cost a dollar, let's say, now it costs $1.05, so you have less real value at your disposal. That's why you will suffer if you bury your savings instead of investing it.

With deflation, the price of that Coke goes down to, let's say, $0.95. Now you have a nickle left over after buying the pop. The real value at your disposal has increased without you having done a thing.

Note that all investments involve some element of risk. The risk of government bonds is that the market will do really well and you'll lose out. Also, inflation may grow faster than the interest rate on the bonds, making them worth less than when you bought them. When deflation is occuring, you are in the position of comparing a risky investment, e.g. the company in which you own stocks may go under, with a more predictable investment like holding the money in a savings account. If deflation is happening at 3%/year and your savings account pays 3%/year, you're now getting approx. 6%/year just for doing nothing! Will you buy stocks & bonds or put your money in a savings account?

You could say, correctly, that banks loan out the money it has in savings accounts so investment shouldn't be affected. However, since the deflation is causing the real value of a dollar to grow, the money a borrower uses to pay back the debt is worth more. The ten dollar monthly payment made today is worth ten dollars in today's real value. If deflation is growing at 3%/year, the ten dollar monthly payment she pays in one year from now will be worth $10.30. She's giving up greater purchasing power as time goes on because the value of money is growing.

This is a tricky idea. Look at the same situation with inflation. The ten dollar monthly payment will buy her dinner and two glasses of beer. One year from now, a ten dollar bill will buy her dinner and only one beer because prices have gone up. The money is less valuable as the general price level rises. When she borrows, the money she pays back over time loses its value. Deflation is the opposite: the money she pays back becomes more expensive; she gives up more purchasing power on the debt as time goes by. For her, she is better off not borrowing right now, but putting her money in a savings account and waiting for the deflations to pass. (I doubt she'll get a loan requiring her to pay negative interest.)

So not only is there a disincentive for her to invest in stocks & bonds but put her money in the bank, there is also a disincentive for her to borrow to put an addition on her house.

IIRC, another problem is that businesses are pinched by the deflation. Say js_motorcorp pays our heroine $1/hour to build cars, then in turns out that prices drop, js_motorcorp is now not really making up for the cost of production. So not only will investment in js_motorcorp go down, but its profit is pinched as well.

That, as I understand it, is why deflation is a bad thing. I hope that wasn't more than you wanted.

ohwilleke

The value of money basically consists of a certain money supply chasing a certain quanity of goods and services. When the money supply goes up, without an accompanying increased supply of goods and services, you get inflation.

Often deflation is caused when the money supply remains constant, or even increases slightly, but the supply of goods and services in the economy decreases dramatically, something that usually only happens in a deep recession. In those cases, the deflation is as much a symptom of the problem as a cause.

echidna

Deflation is a very real risk for the US economy. At moderate levels, interest rates can be an economic tool so that lowering them can be used to stimulate the economy. The problem is that at the moment US interest rates are near rock-bottom & there's nowhere to go.

The risk Greenspan faces, is that by further lowering them he brings the economy closer to deflation, something he probably doesn't want to be remembered in history for.