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Before we go any further, let us get this straight. Inflation is a general rise in the price level. Deflation is a general decrease in the price level. Every textbook presents it this way. Now, a reduction/increase in the money supply will cause deflation/inflation ceteris paribus, but a decrease in the money supply is not deflation. I.e. deflation is a symptom of a lower money supply, not having a lower money supply itself.
Vicente
2011 Aug 5, 5:15am
Inflation is a general rise in the price level.
Many economists refer to it as an increase in the money supply. Thus the change in general prices of goods and services is a symptom or a consequence. Inflation has occurred in past when economies were flooded with new supply of gold/silver or shells or whatever else they used for currency.
Inflation is a general rise in the price level.
Many economists refer to it as an increase in the money supply.
Don't take this the wrong way, but, which ones? Every textbook I have read (mankiw, barro, varian, case, blanchard, friedman) presented inflation/deflation as a change in the general price level. Friedman said that inflation was always a monetary phenomenon, but saying "x is always caused by y" is different from saying "x equals y". Now I freely admit that I am less familiar with the details of the austrian's view of inflation, if that is what you are referencing.
If I am just being overly semantic, then that is fine and I apologize for laboring the point. I am not arguing that a decreased money supply is not deflationary, ceteris paribus, only that it is not in and of itself inflation.
An analogy.
After 1985, pretty much the whole tech industry is a deflationary industry. Next years model will do 2-3x more and will sell for less due to insane competition.
Semis worth their weigh in gold, now pennies on the dollar.. Office Suite cost $300 now free... Netscape Browser would cost you $75. Now free. From $1M mainframes to 1000x more computing thats the size of a lunch box for around $200, monitor and keyboard included.
uomo_senza_nome
2011 Aug 5, 6:48am
Every textbook I have read (mankiw, barro, varian, case, blanchard, friedman) presented inflation/deflation as a change in the general price level.
That is the problem with Keynesian economics. They don't understand the root-cause of the price increase/decrease problem. So they focus on the effect and try to fix the effect through smoke and mirrors (such as quantitative easing). Consumer spending is a problem because too many people got into too much debt.
The market (this includes all participants -- not just Wall Street) wants to reduce the level of debt which spells deflation. Keynesians such as the Bernank and others are scared shit of deflation, because they believe deflation degenerating into a depression is bad. I agree that's bad, but when you go on a serious debt binge, there are only two choices: repudiate it or inflate away. Inflating away reduces the saver's wealth, but I suppose that for the overall economy -- inflating away ensures that the saver at least gets to keep his/her job.
uomo_senza_nome
2011 Aug 5, 6:55am
If you borrow $100 from grandma and give her an IOU in return, and grandma's dog eats the IOU...is the $100 somehow magically 'destroyed' or 'removed' from circulation?
No, what happens though is grandma got screwed because she lost her principal + interest. But however my debt got written away and my ability to borrow also got curtailed. That is credit contraction => decrease in credit => decrease in money supply, because in today's world the dominant medium of exchange is credit.
Rew
2011 Aug 5, 8:31am
Disinflation is typically what people are referring to when they say things like "there is deflation" or "deflationary forces". Disinflation is typically understood as the reduction in the rate of inflation, which can eventually lead to deflation, if we cross the 0 mark into negative interest. inflation.
I currently see deflation commonly being used in very unspecific, but broadly meaningful ways. English is such a flexible and imprecise language, giving it huge advantage, but it leads to us saying things like "credit deflation", "price deflation", and "monetary deflation". All of these which would probably be better understood if the word "deflation" was replaced with "contraction" or even "reduction". A hallmark of a vibrant and alive language is its ever changing state and growth.
So to be more correct, the title of this post would be "Why is Disinflation occurring? An analogy."
Text borrowed from Prof. Steven Keen's blog:
The level of debt compared to GDP is like the distance to be travelled, and today the US has a lot further to travel than it did in the 1950s: 5 times as far, in fact. It’s like the difference between a drive to New York and back, versus a return trip to Utah.
The rate of change of debt (with respect to GDP) is like your speed of travel—the faster you drive, the sooner you’ll get there—but there’s a twist. On the way up, increasing debt makes the journey more pleasant—the additional spending increases aggregate demand—and this experience is what fooled neoclassical economists (who ignore the role of debt) into believing in “the Great Moderationâ€. But it increases the distance you have to travel when you want to reduce debt, which is what the USA is now doing. So it’s great when you’re driving from LA East (increasing debt), but lousy when you want to head home again (and reduce debt).
With that far to travel back home, you might be tempted to accelerate—which is akin to increasing the rate of change of the rate of change of debt (it’s a measure of the g-forces, so to speak, when they can be generated by either rapid acceleration or rapid deceleration). Acceleration in the debt level when it was rising again felt great on the way out: booms in the Ponzi Economy the US has become were driven by accelerations in the rate of growth of debt. Equally, acceleration in the opposite direction feels dreadful: as the rate of decline of debt increases, aggregate demand collapses and unemployment explodes.
What actually feels better in the reverse direction is deceleration—reducing the rate at which debt is falling—and that’s what’s been happening in the last year.
But here’s the problem: too much deceleration and you actually reverse direction: you start heading East again, rather than returning home. That wouldn’t be a problem if all you’d done was drive to Utah, but instead you’ve hit New York instead: drive any further, and you’re in the Atlantic.
With the level of debt the USA has accumulated, the prospect that any sector of it (apart from the government) can be enticed to go back into accumulating debt once again is remote. So the deceleration in the rate of reduction of debt that is occurring right now will ultimately give way to at best a constant rate of decline of debt, and at worst another acceleration—and the dreaded “double dipâ€.
Full link: http://www.debtdeflation.com/blogs/2010/10/19/deleveraging-deceleration-and-the-double-dip/
I can understand why real wage inflation is desired by many people (including Steven Keen). It will reduce the level of debt as it is getting paid with worthless dollars, at the same time you are also not causing a full-blown out depression. How this will exactly happen is not clear to me.
Thoughts?