Deflation is good or not?

Question

Deflation is good or not?

Answer 1

I agree with TRose that a contraction of the economy spells negative growth.

Today, there is less money "on the streets" and hence circulating. When money stops circulating then there is no surplus, disposable income.

Thus consumption of consumer or long-term durable goods contracts and declines. That then signals the distribution chain, form the manufacturer down to the retailer, that orders need to be cut. When orders are cut, jobs are cut. When jobs are cut, unemployment ensues. When unemployment ensues, there is less money on the streets in circulation. Hence, a recession.

When you have a recession without capital growth (as in more factory orders for instance), you the go into what's called stagflation. That is the price of short-term necessaries and living expenses goes up, even though long-term durable goods are cheaper; so there is inflation, but the economy has grown stagnant without corresponding growth.

Without corresponding growth, there can be no increase in personal earnings and increases in wages.

Therefore, wages cannot keep up with the basic necessities which are going up faster than the economy can bear the cost of them.

We are in a stagflation in my opinion, because people cannot afford the tremendous cost of food, energy, and other basic necessities as their income has not increased at the same rate as the price of those things they need.

Answer 2

Deflation can be good if you are debt free and have money in the bank.

Answer 3

The main problems with deflation are as follows.

- Wages are quite inelastic (even in the US). While the price of goods is dropping costs (i.e. wages) remain constant and this will squeeze the profit margin leading to company bankruptcy.

- Consumers will expect prices to keep falling and therefore postpone purchases. Think about computers, their price keeps falling and most of us stick it out as long as we can before making purchases. Imagine if this happened with all products, demand will fall, production will be reduced and in conjunction with the above problem enterprises will really be in trouble (oh, and forget about r&d and investments).

- Investors will also be reluctant to spend, invest etc. Money now will actually be gaining value and this would attract funds from the loan market... increase the interest rate etc.

Japan suffered many years from deflation and the economy was hit hard.

These are the reasons for which central banks target (or desire) small positive inflation rates (around 2%) instead of zero or negative inflation rates.

Answer 4

Deflation is BAD because it causes prices to decrease -- more accurately, it cause the money supply (think of this as credit) to decrease. Why is this bad? Deflation causes the economy to contract instead of growing. When an economy is contracting, jobs aren't created and businesses aren't investing thus reducing the ability for the economy to expand.

Take the current housing problem, even though housing prices are overall falling, most people aren't able to get a loan or afford to buy because banks don't have the capital to lend and / or have tighter lending requirements. This restricts the circulation of money (money supply). The more money is able to circulate the more hands it touches, thus the more it is able to be used. If it isn't being used then it can't create new jobs and more innovation, which allows for an increase in the standard of living.

This is a very basic example, but you should get the gist.

-- cheers