#Deflation #EconomicImpact #Inflation #Macroeconomics
Deflation, the opposite of inflation, is a decrease in the general price level of goods and services in an economy. While at first glance, it may seem like deflation would be a good thing because it would make your money more valuable, the truth is that deflation can have serious negative effects on the economy and individuals. Let’s dive into why deflation can be bad and the potential consequences it can have.
## Why is Deflation Bad?
### 1. Debt Burden Increases
– When deflation occurs, the value of money increases, which means that the purchasing power of consumers increases. However, this also means that the value of debts and loans increases, making it more difficult for individuals and businesses to repay their debts.
### 2. Decline in Consumer Spending
– In a deflationary environment, consumers may hold off on making purchases because they expect prices to continue falling. This decrease in consumer spending can lead to a decrease in business revenue and potentially result in layoffs and unemployment.
### 3. Decrease in Investment
– Deflation can create a lack of confidence in the economy, causing businesses to hold off on making investments and expansions. This can lead to a stagnation in economic growth and development.
### 4. Nominal Wages
– During deflation, nominal wages, or the amount of money workers are paid, may decrease. This can result in lower disposable income for individuals and ultimately lead to a decrease in overall demand for goods and services.
### 5. Economic Recession
– The combination of decreased consumer spending, investment, and job losses can lead to a full-blown economic recession. This can have widespread negative impacts on the economy, including decreased production, lower GDP, and increased poverty.
## Examples of Deflation Impact
### The Great Depression
– One of the most well-known examples of the detrimental effects of deflation is the Great Depression in the 1930s. During this time, prices fell significantly, resulting in a sharp decline in economic activity, widespread unemployment, and severe financial hardship for many Americans.
### Japan’s Lost Decade
– In the 1990s, Japan experienced a period of deflation that lasted for over a decade. This prolonged deflationary period had negative effects on the economy, including stagnant growth, high unemployment, and a decrease in living standards for many citizens.
## Conclusion
In conclusion, while it may seem counterintuitive, deflation can have serious negative impacts on an economy. Its effects on debt burden, consumer spending, investment, wages, and overall economic growth can lead to widespread hardship and instability. While inflation can sometimes be viewed as a burden, it is important to recognize that a moderate and controlled level of inflation is often preferable to the potential consequences of deflation.
Imagine you had $100 to buy a tv today. But tomorrow that tv will cost $90. The day after that? $80. You would wait to purchase the tv until you believed the price hit bottom. But you don’t know when that is. So you delay the purchase forever. No one spending money on goods and services is bad for everyone. So deflation is bad. Mild inflation encourages the purchase of goods and services today which keeps the economy humming along.
It wouldn’t. Someone will come in and say how deflation will cause people to hoard their money, nobody will buy anything, and the economy will grind to a halt.
*They are wrong*.
Their argument ignores the most simple thing: people want stuff. Deflation would lower people’s time preference, making them more willing to defer consumption until a later time, but nobody has a time preference of zero. The key is people will *defer* consumption, they will still consume, just later, when a more useful, or durable product is available.
In the meantime, deflation will encourage saving (and future-oriented thinking), and will reduce the desire to mindlessly consume cheap plastic crap that you don’t need. It will also reduce the need to invest in assets just to maintain your wealth, which in turn will lower asset prices and make things more affordable for the people who want them for their utility, instead of just wanting them as a wealth storage mechanism (in case it’s not obvious, I’m referring mainly to property here).
Edit: to everyone saying how this would cause businesses to collapse due to lack of income, and jobs to be lost, you’re forgetting that all of the newly unemployed will be able to support themselves for a while, since they’ve all been hoarding money. they would be forced to spend, since they have no income and immediate needs, which would in turn keep open the businesses that you say will close. as always, an equilibrium will be reached, which is startlingly obvious after considering the problem for any length of time whatsoever.
Edit 2: I’ll stop replying now that the inflation-loving brigade has arrived. to anyone actually listening instead of regurgitating what central bankers make you swallow, check out the mises institute and read some books by Austrian economists (the Austrian school of economics, not the country). to everyone else, see you in fifty years when your money is worth 98% less than today.
It’s bad for a few reasons:
– If people think prices will go down in the future, they put off spending today. This causes a slowdown in economic activity as sales fall, companies lay people off, those people have no choice but to spend less and sales fall further, and it becomes a vicious downward spiral of recession.
– If people think their money will already be worth more in the future, they have less incentive to invest it, put it into a savings account or CD, etc. meaning that banks have less money to lend to home buyers, car buyers, businesses. Businesses wanting to go public have less demand for shares making it harder to raise capital to expand.
– If prices fall, so too will wages. And that’s demoralizing to workers to see their pay go down instead of up. There’s a psychological benefit to seeing pay go up, even if it doesn’t translate to buying power due to inflation.
deflation means you money is worth more tomorrow than it does today…
ie. everything gets cheaper day by day…
if that is the case, why would you buy anything today? the more you wait you less you have to spend… everybody would do this, therefore the economy would grind to a standstill as everyone is hoarding money and not spending it…
The key that most people miss about deflation is that economists aren’t particularly worried about it discouraging consumption. Deflation discourages investment.
Lets say you’ve got enough money to build a factory. You expect that factory to grow your wealth by 2% a year. Well if deflation is at 5% a year, you expect to make more money stuffing that money under your mattress and sitting on it. So you don’t build the factory. Nothing gets made at the factory. No one gets employed at your factory. Businesses around the factory don’t get a bump in customers from the employees at the factory.
On the other hand, if inflation is 5%, you would absolutely build that factory. You expect your wealth to drop by 5% a year if you sit on it. With that much deflation you’d even build the factory if you expect it to lose a bit of wealth. After all even if the factory is going to lose 2% a year, that’s still better than holding cash.
That lack of investment caused by deflation is horrible for the economy, particularly in the long term.
Now the other hand, if inflation gets too high, it causes some pretty serious problems for consumers. But economists have figured out that a low amount of inflation (around 2% per year) has little to no impact on consumers, while also working to prevent deflation.
You just have to look at Japan. It has been in a longterm deflationary period and it is objectively considered one of the worst countries on the planet /s.
One way that deflation is bad is that it potentially makes already existing loans ‘more expensive’.
Over longer time periods, cumulative inflation tends to make loans easier to pay off because towards the end of your 30 year mortgage, that last $100k you owe is worth less than $100k was worth when you first took out that loan.
Deflation could create the opposite conditions, where it gets harder to pay off a loan if the value of each dollar goes up.
Many of these posts are answering from the perspective of the consumer.
But the main reason deflation is bad is because it discourages *producers* from producing.
If I have a business with $1 million in the bank, what I normally do is build $1 million worth of product and sell it for more than $1 million. I make a profit and I use that profit to build more product, paying suppliers and employees along the way, and the cycle continues.
Now with deflation, I build that product, sell it, and I could end up with *less* money than I started with. So why not just keep the money in the bank? Why would I do the work to build my product when I would end up with less money? So instead I do nothing; I don’t buy any raw materials and I lay off employees because they aren’t doing anything. This contributes to a spiral where nothing is happening in the economy, nothing is being produced, and every employer decides the least bad alternative is to put their business on pause and stop paying employees.
It’s more about what deflation means about the underlying economy.
Economy wide deflation means that nearly *every* seller of goods and services feels the need to lower prices. Usually, that would mean lower demand across nearly all goods and services. Ie people have stopped buying.
If people have stopped buying economy wide that means two things:
1) Income is being sucked out of the economy. Prices aren’t just going down and incomes are staying the same. Incomes have probably gone down somewhere and consumers are shaken up. Layoffs are increasing.
2) If people are not buying, that means overall GDP goes down (a big part of our economy is consumption). So companies start getting more pessimistic and cut costs.
This results in a vicious cycle where there is more income being sucked out of the economy and consumption falls, there is deflation, etc.
An economy that is deflating *economy wide* means that it is probably sick.
When deflation happens, the dollar is losing value. This means any holdings you have are losing value.
So what do you do? You sell off those holdings for less than you got them for.
What does this do? Well, it causes deflation. Go back to step one and repeat.
The economy and people struggling because their money loses value is less bad than people not spending money and collapsing the economy.
Inflation incentivices money spending because you want to get rid of the money as fast as you can before it loses to much effective value or buying power. This keeps the economy going. Deflation incentivizes hoarding your money because it will gain value by not spending it. The money that now doesn’t flow into the economy leads to cuts in workers and products. The workers out of a job now don’t have expendable wages and will try to ration their money as best as possible and even less money is flowing into the economy until no one is spending money aside from essentials and the market collapses.
Imagine if your student loan payments or mortgage kept rising as interest compounded, but your income was adjusted downwards for cost of living adjustment each year. With deflation, you have a shrinking supply of dollars. Each dollar buys more goods, but there is less to go around.
In deflation, people with debt lose HARD, and debt issuers win big.
With inflation, people that loan money lose out a bit, while borrowers/people that have long term debt tend to outgrow their obligations over a long time frame.
It’s not that inflation is good or bad. It’s about STABILITY. You just want your money supply and cost of goods to move generally in line with the growth of the economy. A moderate, controlled inflation supports a growing economy and facilitates growth and economic development, while deflation makes debt very punishing, and stifles growth.
Can anyone here explaining how inflation is vital also please explain what happens when wages continue to not rise in line with inflation, after longer periods of time? If everything just becomes more expensive and the majority of people can’t afford basic things? LI5
I don’t get how I get my posts removed for questions I’ve never seen on here before but this question gets asked like twice a week and they all stay up.
For money to work you need it moving (people using it).
The threat of money losing value (inflation) makes you do something with it. Buy things you want, or invest your money (allowing other people to use it).
If everyone thinks money increases in value over time, money stops moving. Because you would use as little as possible in an attempt to hoard as much as you can.
This would mean no incentive for competition. No incentive to start a business. No incentive to invest.
It would be a feedback loop that quicky implodes and destroys money and our way of life.
In addition to what everyone has said, sure goods may become cheaper, but debt that you carry becomes more expensive and harder to pay off. Given the amount of consumer debt carried by the average American, this would be a nightmare.
Most people will give you an explanation framed from a macroeconomic perspective. I thought it would also help to give a more personal perspective.
Deflation means your money becomes more valuable over time: it takes less money to buy comparable goods.
For most goods and services, businesses would try to compensate to balance things out so that the time it took you to earn enough to buy something stays about the same. So things might cost less, but you’re also being paid less.
But not everyone can do that. Most notably, when it comes to debt or other fixed cost agreements, you’re still on the hook for the agreed upon amount.
Deflation is thus bad for debtors. You’re making less money, but your debt is staying the same. It would be like paying today’s price, but on your grandparents’ wages.
Conversely, inflation is good for debtors because that’s like getting paid today’s wages to pay your grandparents’ mortgage.
In a debt based economy it would destroy it. If people had savings and money was backed by gold it would be a different story. In our current Ponzi scheme fiat system it is just impossible.
I think the issue that’s causing you to talk past people here is the idea of microeconomics vs macroeconomics. You’re talking about your personal life and what decisions you might make or how you would directly interact with the economy. This is very different from the large scale economic activity of an entire country.
You want a new phone. It costs $500 today.
Tomorrow it will cost 499.
In a year it will cost $350.
In 2 years it will cost $200.
Why would you not wait? Same with food, cars, houses, etc. who would buy anything they didn’t absolutely need?
Deflation would be the result of demand growing slower than supply, and so suppliers reducing prices in order to sell their stock.
The problem is them having less revenue to cover their costs. Eventually they’re going to go into survival mode, ie. cutting their costs. The largest cost is usually labour costs – and so job layoffs occur.
As more people lose jobs, theres less people buying stuff, and so prices go down even further.
This is basically a recession and a shrinking economy. Less demand for goods means less need for jobs.
Overall, people will begrudgingly accept that prices will go up. Being unemployed is far less tolerable.
Money’s loss of value is intentional. It’s just paper, metal coins and numbers on screen. But in being spent and triggering a need for more goods and services, along with investing into businesses, it creates jobs – and tax revenue that comes as a result of economic activity. Money isn’t printed for the purposes of hoarding.
– **Everyone is incentivized to sit on their money.** The value of your money going up means you want to hoarde it and not spend. You want savings. But money in the bank doesn’t actually do the economy any good. It’s the exchange of money which is the economy.
– **Loans get harder to pay off**. It’s a sneaky extra added interest rate. People will have a harder time paying off loans so banks have to be more careful about who they loan to. ALSO, as mentioned, it’s better to sit on your money, so banks wouldn’t want to loan out money unless it had an even bigger interest rate. (Although, same goes for when there’s high inflation).
– **Wages go down**. In the a exact way that [wages have gone up with inflation](https://www.piie.com/research/piie-charts/us-wages-lowest-earners-are-growing-fastest-rate-global-financial-crisis), once money is worth more companies are REAL quick to cut wages.
oh man, some nutcase on here were recently pushing some of the most ridiculous propaganda that deflation was a good thing. But they were crazy liberatarian gold-standard advocates that just really hate the Fed and fiat currency. Crypto-bros, ugh.
It isn’t. In fact, we’re overdue for and need an asset crash if we want housing and cars to be affordable again. The examples given in this thread assume extreme deflation. Yes, if something is going to cost 10% less every day, then I’ll keep putting it off. That’s just as bad as 10% a day inflation forcing me to spend everything i can immediately. However, as a real world example, tech prices fall rapidly regularly, yet people still line up to buy the new iPhone and Galaxy phones the day they come out, and Apple and Samsung are still 2 of the largest companies in the world. It doesn’t stop their investment either.
No one is putting off buying food because it’ll cost 2% less next year. Same with gas, shelter, transportation to and from work, etc…
Deflation means your money is worth more tomorrow than it is today. It would therefore be prudent to put everything you can under a mattress, because you can buy more with it tomorrow. And even more the day after.
People still need food, water, energy and shelter; so you’re still buying those essential things. However all your discretionary spending your incentivized to hold off on. You’ve no incentive to invest your money, safe move is to lock it away because you’ll be able to buy more with that same money later. It doesn’t stop all discretionary spending, but it does slow it down.
If you have a mortgage or other forms of debt, those are getting relatively more expensive every day. With inflation it was getting relatively cheaper every day. With deflation, every payment you make is worth more than the last. This drives defaults. Because money is more valuable, your $500 000 home is now worth less money. And tomorrow it’s going to be worth even less. But you’re still making payments on the $500k. Relative to deflation your home’s value hasn’t changed, but your loan is still your loan.
Now, because people are spending less than they used to, business start failing. The employees lose their jobs, and the owners lose their investments. New companies are not started, because investing is disincentived and the market is no longer there. So these people that are out of work no longer can afford even the essentials.
Now you have a deflationary death spiral. Your economy has seized up, money is literally moving less and less day after day. More people lose their jobs, or if they are lucky, get their wages cut day after day. Businesses close, banks collapse under a mountain of bad debt. Your money is worth more and more, but getting more of it gets harder and harder until you can’t get any more.
Explanations like mine start at the retail level because it’s easier to explain and to imagine, but the spiral starts small with institutional investors who do care about their money appreciating by 1% or 2% year over year that will act accordingly to protect their positions.
This is why countries have central banks, that are in theory isolated from political influence, who’s sole responsibility is to control the money supply to ensure that you never have deflation and only a low level of inflation. 2% is the typical target as a sort of hedge against some economic stormy weather pushing you into deflation. High levels of inflation is also really bad, but relatively speaking easier to fix than deflation. Still painful though.
Only a small percentage of the money a bank loans out is their own. Banks lend money from the central (aka reserve) bank to lend out to their customers. The interest rate on this loan is the the cost the bank has to pay back, and they charge a higher level of interest to make a profit. This mechanism is how money is added to the money supply (“printing money”) and also removed from the money supply. The more expensive the loan, the less money is borrowed. The central bank changes this base interest rate to encourage or discourage spending as required to maintain the target inflation rate. It’s not perfect, but it works.
you want some inflation because that means the economy is doing well (generally speaking). Deflation generally means the economy sucks.
During deflation, the common people win (short time) and the capitalists lose (big time). And, because the common people depend on the capitalists, they eventually lose too (long term) by losing jobs and sources of income. So everyone loses.
Deflation is only bad because people are producing more stuff than they need thus wastage occurs.
Such wastage causes bankruptcy as well if the businesses borrowed money to produce the excess.
The bankruptcy will cause layoff as well so people will also suffer.
But people who borrow money to survive will not be anymore worse since despite the debts have increased, the price of goods have dropped so as long as they are not working for one of those businesses who produced unwanted goods, they will still end up spending the same amount of money in total for buying and loan paying.
So businesses should just estimate the future demands more accurately and not just keep making more and more of the same stuff as fast as possible.
They should also try to increase efficiency and improve the technology instead of just producing unwanted goods.
It isn’t bad. Deflation discourages investments which means less money for the rich to borrow and interest rates drop so they can’t invest against their own borrowing as effectively.
They scare the poor by saying deflation is bad because their paychecks will shrink and most people can’t equate how that’s not necessarily a bad thing during inflation (or really, that it absolutely has to happen).
In short because it would hurt profits and shareholders.
I don’t know why nobody ever thinks of the shareholders! /s
The stability of the American economy relies on the value of houses going up over time forever. If we were in a situation where there was negative Inflation then all the financial mechanisms rich people use to farm dollars out of basically nowhere would dry up
The few times that it’s happened (pretty rare), people stopped spending, making the economy worse
The theory is, is that people won’t buy today because they believe tomorrow it will be cheaper
I think the fears are overblown. The few times it happened were during sever economic crises like the great depression and people didn’t buy because they were fucking broke, not because they wanted to wait for prices to come down
Deflation isn’t a bad thing. It incentivizes savings. There are a few currencies that operate under the principle of deflation for this very reason
Lots of good answer but I want to add: Not all but at least the top 10 countries by GDP have huge debts that can’t be repaid so they need to keep growing so they can pay the minimum(or more if lucky)
For example: you owe 10$, you pay the minimum at the end of year (1$)
You still owe 10$ but inflation made it that 1$ is now 2$ so you pay 2$ this time. Technically, your debt is now 9$ but instead government just spend more so it either stays 10$ or higher..
It’s the infinite growth theorem and most modern countries use it to finance their non sustainable lifestyle.
Simple answer: money lending. If you buy a house today that costs $500K, get a miraculous APR of 3% (the average annual rate of inflation), then pay it off over 30 years, you’re essentially paying the cost of inflation and the banks don’t make much money on your loan.
If, instead, we are in a deflationary period, you pay more for your house over time than the agreed $500K.
Another virtue of inflation is the prevention of stagnation from trustfund babies. If you inherit 10mil today, but never do anything with the money, in 10 years that money will be worth a lot less, and within 100 years it could be worth near to nothing. By implementing inflationary policy we force the wealthy to maintain their wealth through continued investment.