Fears grow that US economy faces deflation

[Tony]

http://news.ft.com/servlet/ContentS...y&c=StoryFT&cid=1051390103932&p=1012571727088 full article

Fears of deflation in the US rose on Friday as stock prices fell and government bond yields dipped to 45-year lows after a key measure of inflation dropped to its lowest level in 37 years.


The concerns were heightened by reports that Japan's deflation gathered pace in the first quarter with prices down 3.5 per cent from a year ago, their fastest 12-month drop on record.

The fall may fuel concerns that the Japanese economy could be in a deflationary spiral. Japanese prices have been falling since 1995 at an average annual rate of 1 to 2 per cent. The latest figures showed deflation accelerating in the 2002 financial year to 2.2 per cent, a record for a full year.

In the US the yield on 10-year and 30-year US Treasury bonds fell to 3.49 per cent and 4.45 per cent in early trading.

Longer-dated US government bonds have rallied sharply this week, with investors convinced that inflation will remain subdued, having less of an impact on the value of long-term assets.

The Labour Department reported that the 12-month rise in its core consumer price index fell to 1.5 per cent in April, its slowest 12-month rate of increase since January 1966. Strategists said the subsequent fall in bond yields could, however, be positive for the economy. "This is what the Federal Reserve wants," said Dominic Konstam, head of interest rates products research at Credit Suisse First Boston.

Wouldnt deflation be a good thing? How would it have a negative effect on the economy?

 

[Gem]

From what the media told me and my ecomomics classes, here's why it's bad for the economy.

You are a consumer. You see a nice pair of shoes at 100 dollars. You want that pair of shoes. If there was a steady (and healthy) inflation, you'd buy it now, because the price would increase later, therefore making the econmy better (that money will be used to employ people who makes shoes).

But with deflation, you're thinking, why buy now at $100 when I can buy a month later at $90? You wait to buy the shoes, making the economy worse off because you're not spending.

Not the best example: here's a better one.

A corporation wants to buy machinery. It also wants to pay the lowest price for it, to maximize profits. With deflation, they can wait a month or two and buy it later at lower cost. Because of lower and later profits for those who make the machine, the economy is worse off.

Now picture this in thousands, if not millions of cases, and individual loses means a wrose economy.

Gem

 

[Tony]

But when the prices eventually bottom out, wouldn’t the mass purchases revive the economy?

 

[Nikk]

But when the prices eventually bottom out, wouldn’t the mass purchases revive the economy?

Deflation had a destructive effect on economies and societies in the 1930's.

It took mass purchases of things that go bang to end that deflationary cycle. It is generally agreed that this was not entirely a good thing.

 

[Frank Newgent]

just one way
to beat deflation
become self employed
then go on vacation

 

[shanek]

Wouldnt deflation be a good thing? How would it have a negative effect on the economy?

Deflation is a natural part of the business cycle. Its effect is to spur economic spending and allow the hiring of more workers.

Of course, our government abrogated the business cycle decates ago. Since it started interfering, the only period of deflation we had was the Great Depression. This is a big reason why economic recessions last so long these days. A big period of deflation is inevitable after decades of continued inflation unless the government stops meddling in the economy and allows it to balance itself out.

 

[shanek]

From what the media told me and my ecomomics classes, here's why it's bad for the economy.

You are a consumer. You see a nice pair of shoes at 100 dollars. You want that pair of shoes. If there was a steady (and healthy) inflation, you'd buy it now, because the price would increase later, therefore making the econmy better (that money will be used to employ people who makes shoes).

But with deflation, you're thinking, why buy now at $100 when I can buy a month later at $90? You wait to buy the shoes, making the economy worse off because you're not spending.

Not the best example: here's a better one.

A corporation wants to buy machinery. It also wants to pay the lowest price for it, to maximize profits. With deflation, they can wait a month or two and buy it later at lower cost. Because of lower and later profits for those who make the machine, the economy is worse off.

Now picture this in thousands, if not millions of cases, and individual loses means a wrose economy.

The problem with that argument is that nobody can predict how long the deflation will last, and so will want to move when they feel prices are low enough. It's just like with interest rates: When the Fed started lowering rates this last time around, it spurned new investments because no one knew for sure if they were going to lower them again. Of course, they did, because they hadn't lowered them enough int he first place (to give us a "soft landing"), and the later interest rate cuts were actually less effective than the earlier ones because most of the investors who were waiting for the lower rates had already acted.

 

[shanek]

Deflation had a destructive effect on economies and societies in the 1930's.

It took mass purchases of things that go bang to end that deflationary cycle. It is generally agreed that this was not entirely a good thing.

That period of deflation was caused by the Fed putting the brakes on the money supply and refusing to let it back in. The "mass purchases" you speak of happened when the Fed finally released their stranglehold on the money supply, encouraged by a government wanting to fight a war.

 

[Leif Roar]

Re: Re: Fears grow that US economy faces deflation

Deflation is a natural part of the business cycle. Its effect is to spur economic spending and allow the hiring of more workers.

As buisness is a human artifact, isn't it pointless to talk about a "natural part of the business cycle"?

Furthemore, just what do you mean by saying it's a "natural part" - that it's something that's naturally occuring in a system (as is disease or tumors in the human body), or are you just trying to add a sense of "healthy wholeness" to the concept?

 

[shanek]

Re: Re: Re: Fears grow that US economy faces deflation

As buisness is a human artifact, isn't it pointless to talk about a "natural part of the business cycle"?

No, because humans are a part of nature and have natural tendencies just like everything else in nature. Human commerce is no exception.

Furthemore, just what do you mean by saying it's a "natural part" - that it's something that's naturally occuring in a system (as is disease or tumors in the human body), or are you just trying to add a sense of "healthy wholeness" to the concept?

The business model is a description of how the economy grows and stays as close to the level of total production as possible. Since it's impossible to tell precisely where it is, it's going to oscillate above and below that level. But as it moves away from that level, there are certain effects that move it back. No one has to make it happen; it just does. And trying to make it happen is a recipe for disaster.

 

[Leif Roar]

Re: Re: Re: Re: Fears grow that US economy faces deflation

No, because humans are a part of nature and have natural tendencies just like everything else in nature. Human commerce is no exception.

The trouble with this kind of useage is that then everything is "natural" and the word loses all meaning. Using this line of logic, one might equally well claim that goverment interferecne with the free market is "natural".

 

[shanek]

Re: Re: Re: Re: Re: Fears grow that US economy faces deflation

The trouble with this kind of useage is that then everything is "natural" and the word loses all meaning. Using this line of logic, one might equally well claim that goverment interferecne with the free market is "natural".

Not at all. Government interference is a direct result of conscious action. The business model isn't; no one "makes" it happen, no one wills it to happen; it just does, hence it's natural.

 

[Leif Roar]

Re: Re: Re: Re: Re: Re: Fears grow that US economy faces deflation

Not at all. Government interference is a direct result of conscious action. The business model isn't; no one "makes" it happen, no one wills it to happen; it just does, hence it's natural.

So rather than "natural" you could equally well have used "thoughtless"? ;-)

 

[Underemployed]

A far more insidious threat to an economy suffering sustained deflation is the one outlined in a Financial Times article recently (17th May) when a reporter discussed the situation in Japan, where deflation is well into its stride. I paraphrase:

With no inflation to speak of there is no return on money left in banks - in fact, banks are now forced to charge you just to keep your money, so the Japanese people are hoarding it at home in record amounts. Approximately $300bn worth of Yen can be found in the nation's cupboards, mattresses and fridges.

Cash is paradoxically becoming more valuable as it is hoarded, so individual purchasing power is actually increasing, especially as shops are forced to lower prices because nobody is buying. They are not spending partly because of the reasons outlined above (prices might fall even lower in the future) but also because everyone is in fear of their jobs and pensions.

With less business coming in, shops and factories cannot employ as many people. More layoffs cause more uncertainty and hoarding. Which causes prices to lower further in a vain attempt to generate sales. Which causes...

Now, the Japanese economy is not the US economy and things will play out differently there. But whichever way you look at it, sustained deflation is no good for an economy.

 

[shanek]

Re: Re: Re: Re: Re: Re: Re: Fears grow that US economy faces deflation

So rather than "natural" you could equally well have used "thoughtless"? ;-)

No, thoughtless still implies a deliberate action, just one that's ill-considered. "Thoughtless" could very easily apply to government involvement in the economy.

 

[shanek]

Now, the Japanese economy is not the US economy and things will play out differently there. But whichever way you look at it, sustained deflation is no good for an economy.

This is true. Sustained deflation can be as bad as sutained inflation (like what the US has been experiencing). But limited, periodic inflation and deflation can be desirable.