Hacker News Reader

> The theory that deflation is bad for an economy doesn't say "but only when that economy is over a certain size". It is an absolute theory that claims to apply everywhere.

But having an economy that uses currency X, but does much of its trade in currency Y, changes the dynamic compared to considering an economy in isolation, doesn't it?

> But you don't really need data to convince yourself that the 2%-inflation-is-best theory is nonsense. Basic common sense should be good enough. The entire thing rests on the assumption that there's a class of investments that people would refuse to invest in if left to their own devices, but which suddenly become attractive only if their savings are shrivelled by a few percent a year. Such a class of investments certainly does exist: they're called bad investments!

I think you're missing the basis for the 2%-inflation-is-best theory. Let's start with this: When is deflation bad? Deflation is bad when it's sustained enough that your salary goes down, and you owe money. And if there are enough people in that circumstance, it's bad for the economy as a whole, because a bunch of people default on their debts, which tends to cause a depression. A mild deflation that doesn't lead to lower wages, on the other hand, is probably good for the economy as a whole.

But here's the thing: When deflation is bad for the economy, it tends to be really bad. The central bank would prefer to avoid that situation. 2% inflation leaves them a bit of room before they run into that circumstance, so that they can try to maneuver to avoid it.

Deflation is bad because

- you earn a rate of return on simply sitting on money. Doing nothing competes with investing. If deflation is 5%, why bother making an investment that could return 5%? Why does a rich person deserve to earn a rate of return on their wealth for nothing?

- deflation incentivizes non-spending. People will delay purchases if they expect prices to decrease in the future.

- deflation necessitates nominal pay cuts. People are psychologically unwilling to accept pay cuts. This leads to layoffs, strikes, labor unrest.

- deflation necessitates a decrease in nominal aggregate income. Your savings growing by 2% sounds nice, but most people's cash savings is a tiny fraction of their future income. Your income will go down. Own any stocks? Those could decrease in value every year.

- deflation increases the cost of debt. How would you like it if your credit card debt or student loan debt grew by 2% every year?

These points seem rational but seem more and more superficial as I think about them.

- A 5% return on an investment coupled with 5% deflation is equivalent to about a 10.5% return. Economically ideal rational actors will continue to invest.

- The majority of purchases people make are not delayable: utility fees need to be paid if you wish to continue receiving them, food must be purchased, renting is money thrown in the garbage as is. Everything else that people have to save for, they will normally purchase the minute they are able because they feel the vacuum.

- Necessity of pay cuts doesn't follow from deflation but rather from depression. Unlike the other points you don't attempt to defend this premise.

- Repeat of prior point.

- The debt won't grow. The normal argument should be that your salary will decrease by 2% each year so effectively the original principle grows, but this is an effect of depression, not deflation.

The idea that deflation leads to depression is because people argue that it will lead to non-spending. However, my experience with real people, as opposed to theoretically idealized "rational" actors tells me that the minute they can afford to spend more, they will. The evidence on people winning the lottery is similar: most people do not invest, but rather spend quickly and emphatically.

I think you're mixing up real (inflation/deflation-adjusted) and nominal (not inflation-adjusted).

- nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0. But it seems more likely to me that the real return of any particular investment opportunity would remain relatively constant rather than the nominal return. I'm not too sure about this one

- I think that a majority of investment decisions (in dollar terms) are made by people not living paycheck-to-paycheck. I think you still might be right in practice, though

- If there's deflation of 2%, then to pay your employees the same amount in real terms, you have to cut their nominal pay by 2%, which people really dislike

- This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes

- Debts are usually measured in nominal terms, so if you have a loan that says $100 but that $100 is now worth 2% more than it was before, your debt has increased in real terms

> nerfhammer probably meant a nominal return of 5%, which when combined with 5% deflation is 0.

What nerfhammer meant was that a 5% deflation is EQUIVALENT to a 5% nominal rate of return in a 0% inflation market.

In other words, during deflation, sitting on cash makes the cash more valuable. Deflation is a dis-incentive to invest, share money, start projects, or seek profits.

Excellent point. In other words, if you can earn a 5% (real) risk-free return by stuffing $100 bills under your mattress, you're much less likely to make a risky investment expected to make a 6% (real) return, and definitely won't make any investments earning 4%.

> This point of nerfhammer I think is wrong. If the value of your stock holdings goes down by 2% every year, but keeps the same purchasing power, the only difference to you is that you don't pay any capital gains taxes

The difference is you would be better off holding cash. The stock's value is constant in real terms, the value of cash increases.

> A 5% return on an investment coupled with 5% deflation is equivalent to about a 10.5% return. Economically ideal rational actors will continue to invest.

You need a 10% real return in order to make the equivalent of a 5% non-deflation real return. It might seem like it's just adding the the amount of deflation, but it's not: income must drop over time. Your investment vehicle will pay out less in nominal terms. You start a muffin shop - they need to charge lower prices than when the investment was made, and will need to repay their investors less. You invest in a startup - it takes five years for the buyout to happen, but now money is worth more so the nominal price they get sold for is lower. Because there is always a time component to investing, investments need to compete with deflation, they don't automatically just add returns on top of it.

> The majority of purchases people make are not delayable...

There is plenty of empirical evidence that people do delay purchases during deflation, e.g. https://ideas.repec.org/p/hst/hstdps/d05-98.html

Even assuming it's not a majority of purchases, if people cut spending by only 15-25% that's still enough to be quite deleterious for the economy.

> Necessity of pay cuts doesn't follow from deflation but rather from depression.

Yes it does. Under deflation in order to pay people the same in real terms you have to pay them less in nominal terms. The whole point of deflation is that everyone cuts prices. This means that companies will end up with less income, and have to pass that on to their employees. People absolutely hate pay cuts, and often layoffs end up being used instead.

> The debt won't grow.

Yes it will. The real value of $1 increases. If you debt is denominated in dollars, the value of your debt increases. The equivalent amount of work you will have to do to pay off the debt increases.

> But having an economy that uses currency X, but does much of its trade in currency Y, changes the dynamic compared to considering an economy in isolation, doesn't it?

Salaries are the deciding factor. Are swiss employment contracts set mainly in Francs or Euros?

If I understand correctly, some of each.

I'm not sure where that leaves us in terms of conclusions, though...

Inflation is equally bad for people who are owed money: by arbitrarily defining one as better than another you're merely siding with debtors over creditors. You can't say "people defaulting on their debts causes depression" yet simultaneously believe "debts being inflated away doesn't": in both cases the lenders lose their money and will lend less in future.

I think there's a much simpler approach: abolish central banks entirely. They're relics of the past, an ode to centrally planned economies. Yellen can raise an eyebrow and the markets move in response, behaviour which is helpful to nobody.

I suspect if we did this (and possibly moved towards full reserve banking) what we'd end up with is a state of very mild deflation equal to GDP growth, as in a growing economy you'd get more goods and services mapped to the same quantity of money i.e. each unit would be worth slightly more. But this cannot cause a downward spiral by definition, because if the economy stopped growing then the deflation would go away as well.

This would result in an economy where technological and social progress over time would result in falling prices; which is what we'd intuitively expect.

> Inflation is equally bad for people who are owed money

Absolutely.

> by arbitrarily defining one as better than another you're merely siding with debtors over creditors.

Not quite. Inflation expectations are built into the price of lending money; if inflation increases more than expected, lenders get hurt, but they're charging enough interest that they think it fairly compensates them for the risk.

On the other hand, deflation risks are typically not built into loans. For example, many adjustible-rate loans have a minimum interest rate; if the rate of inflation goes below zero, the interest rate will stop at, say, positive 4%. This asymmetry makes deflation worse.

> The theory that deflation is bad for an economy doesn't say "but only when that economy is over a certain size". It is an absolute theory that claims to apply everywhere.

Please cite an economist saying that.

Here you go.[1]

[1] http://krugman.blogs.nytimes.com/2010/08/02/why-is-deflation...

> If the economy is doing well, all this can be offset by just keeping interest rates low

There's your condition; there can be others that don't fit into a single blog post aimed at American readers. Various deflationary measures are also recommended by orthodox economists in cases of hyperinflation.

I cited an economist who never mentioned anything about the size of an economy when talking the evils of deflation. You are moving the goalposts.

What is your new demand? That I prove a negative? That I have to quote an economist who says "deflation is bad, no matter the size of the economy"? The post you responded to said: "The theory that deflation is bad for an economy doesn't say "but only when that economy is over a certain size". It is an absolute theory that claims to apply everywhere.", not that deflation hawks said economy size doesn't matter (it is implied through omission).

Please accept that your curt and dismissive comment was falsified by a random commenter on HN who spent literally 30 seconds on Google, and typed in "Krugman deflation<CR>".

I am looking for a claim that "deflation is bad... is an absolute theory that [applies] everywhere." 'Size of economy' is just one possible exception that would belie an absolute theory that applies everywhere.

By the way, I have not been insulting to you, and I would appreciate the same consideration.

So, how do we explain Japan? It's been deflationary for decades and the economy hasn't improved in real or relative terms.

Is their deflation different, to borrow a phrase, or is CH's deflation a bit unique?

I'd love to see a contrast btwn CH and JP in this regard. Or, how could Japan stop worrying and love deflation, Swiss style.

I'd chip in several thousand dollars to have a study commissioned to answer these questions. I've believed all of the above for years (RE Japen), but would be interested if my beliefs intersect with data and facts.

Switzerland's deflation is unique in that it's the result of their currency drastically gaining value on the currency of their neighbors. It's more of a price adjustment and doesn't really show the signs of a deflationary spiral... Domestic goods still increased in price, as did housing, but imported goods brought down basket prices.

At its peak of the Japanese Asset Bubble, the Imperial Palace of Japan was valued higher than the sum of all real estate in the state of California. Simply put, the Japanese Asset Bubble was the worst asset bubble in the history of asset bubbles.

In order to stabilize the collapse of the asset bubble, they have been playing loosey-goosey with interest rates for two decades now. But in order to stabilize the fall in asset prices using monetary policy (a blunt instrument if there ever was one), they essentially have been inflating everything else. So while they have nominally had deflation in aggregate, they have had inflation levels in consumables (which is about 70% of the cost of living) that are bordering, if not surpassed, what most economists would call HyperInflation.

I find the factoid about the imperial palace hard to believe. Can you point me at some source/supporting evidence?

http://www.thebubblebubble.com/japan-bubble/

But how can they have wage deflation while their cost of living, not counting housing, has experienced, as you put it, hyperinflation?

Meh, I should probably clarify that I'm not an expert and I'm just regurgitating an explanation given to me by a (Japanese) econ professor a few years ago. I don't know how to answer your question.

Japan's economy isn't actually in depression, it's merely not growing: GDP growth moves up and down around the zero mark since the popping of their massive asset bubble. Some years their GDP grows a bit, other years it shrinks a bit. So they haven't been growing but they haven't been in depression either.

There's a simple explanation for that. The very best developed economies struggle in these times to grow even at 2%, with most managing more like 1%. Since the start of the 90's the UK, for example, has managed only 1%. That's not totally surprising: GDP growth is cumulative. Each year repeating a 2% growth gets harder and harder because you have to add even more than you did last year to sustain it in percentage terms.

But Japan is in no way the very best of economies. Instead it has an economy seriously constrained by multiple factors, like an almost total lack of immigration (no new ideas) and a job-for-life culture that makes it practically impossible to fire people. Read up on "banishment rooms" to see how extreme that can really get. When was the last time Japan had a brand new, breakout product that the world swooned over? Since Nintendo lost their mojo I'm struggling to think of any. It's very rare that I interact with any company from Japan or hear "I went to Japan on a business trip".

Japan's economic woes have multiple causes: I think a far simpler explanation than "zomg deflation" is that when even the best struggle to manage 1% compounding growth Japan has no chance.

I dont think anyone credible would claim Japan is in a depression but rather it has experienced deflation and very weak growth. Or how do we explain parasite children?

Immigration is one solution to their problem, but not _the_ solution if were looking at the domestic demand side. Immigrants don't magically bring innovation, unless you're talking about very educated immigrants which typically are a tiny fraction of any immigrant group.

There are lots of immigrants to Turkey and Bahrain even Mexico (though net looks different due to their outflows) but, no, I think Japan's issues are structural. They have a perverse system of incentives which plough too much into useless infrastructure and also their workplace culture. That's not to say they aren't innovating, they continue to innovate, it's just that they have not adapted well to globalization, and internal consumption hasn't compensated for the slack. That said, in this liberal economic context of today, deflation is not a good thing. Or ask Japanese how they feel about their economy.

Well, the point is the deflation-is-dangerous theory says it must be avoided at all costs because it leads to a downward spiral that ends in depression. But Japan is a counter-example that shows this theory cannot be true.

There's no One True Solution to Japan's problems. Skilled immigration can help, by bringing outside experience and ideas into the mix. Look at how many successful American companies were either founded or are now run by immigrants (e.g. Google, Microsoft). But Japan barely even has that.

Your last sentences are a bit puzzling to me: you seem to agree that deflation has not led to depression and that Japan's economic issues are more structural than currency related. But then you just repeat the claim that deflation is not a good thing and point to Japan as an example!

The way I see it is any sudden change in the money supply is bad news because business likes predictability. The ideal monetary policy therefore would in fact target price stability (0% inflation) or mild deflation (as progress should mean things get cheaper over time). But you can't just say "deflation is bad" and then point to one country as an example, given that this entire thread is about the counterexample of Switzerland!

The way I see it, it, yes, one day, when all economies' slack has become taut and we're near equilibrium in terms of pop at least, then, at that point neo liberal economics predicated on growth will have outlived it's usefulness and will no longer deliver what society needs economically.

When we get there growth will cease to be essential. In the meantime, growth and thus inflation, will be indicators of robust economies.

Pervasive automation population decline and resource constraints (environmental stewardship) will have effects in the future whereby growth will not be an expression.

But Japan, at the moment, has a population in decline, a lousy job market, stagnant wages, graduates taking lousy offers, more temp workers (not their parents' job security) all things most people would typically want to avoid in their economies.

See if you can sell Russia, China, Mexico or Indonesia on deflationary economics.

Stability means no innovation. Likely prices didn't change much for a pair of shoes between the fifth and sixth centuries. Great price stability. Is that something to look forward to? Little in the way of innovation, manufacturing, technique, sourcing, etc?

Inflation/deflation is just one of many factors that affect the health of an economy, sure. But on a micro level, deflation is very bad for anyone with debt in the deflating currency. In countries where that class includes a large portion of the population, deflation is bad for the economy as a whole.

> The entire thing rests on the assumption that there's a class of investments that people would refuse to invest in if left to their own devices, but which suddenly become attractive only if their savings are shrivelled by a few percent a year. Such a class of investments certainly does exist: they're called bad investments!

That makes so much sense. The main argument against inflation is that if people see the value of their money increase, they will stop spending it and instead hold onto with the expectation that the value will rise further. That's certainly true of investors, who tend to panic sell anything that fails to outperform the dollar. But most people don't see their money as a commodity - they will only notice that the price of consumer goods is falling, and use that as a justification to spend more. So deflation is only really bad for Wall Street. Inflation subsidizes the stock market.

> The main argument against inflation is that if people see the value of their money increase

this is the main argument against DEflation, is it not?

One problem with deflation is that it means wages go down too. Even if price levels go down (which, as you said, should spur demand), lower wages cause consumers to hoard money, which causes the value of money to go up, which causes more hoarding, which causes prices to go down, etc...

It's not called a deflationary spiral for nothing.

There are many reasons why inflation is a good thing - wages go up (people like that), the value of investments goes up (people like that), and while it doesn't always correlate to inflation, the money supply needs to increase over time as the population increases, otherwise you'll have some major demographic issues...

I don't think deflation has to drive wages down actually. Deflation simply means that your dollar (or CHF) can buy more tomorrow than today, and hence unless you can invest in something that appreciates faster than that rate, you would keep the money in cash rather than spending it, unless your expense is really necessary (say food). Inflation then of course means that your money is worth more today than tomorrow, and therefore you are more likely to spend it (and more investments become attractive, as long as they perform better than the currency).

Will wages come down, over time in a purely deflationary economy probably yes. But unlike most inflationary economies where it is usual to have a x% salary growth y/y, I think the barrier to sign a contract that says: "your salary is X, and will decrease by z% per year" is a lot higher. So, if a country has only mild deflation - like Switzerland - the real value is actually likely to go up.

> wages go up (people like that)

That's also not a given, its likely to have a raise in contracts, but if I promise you a 2% yearly raise with inflation of 3% you are not really getting a great deal, are you?

> [..] major demographic issues

True, I see inflation as a great way to equally tax 'old money', and in a way that is almost impossible to escape.

In the end inflation is good for those with debt (governments/corporations are first in line), deflation is great for those with cash (but not necessarily other assets, those will probably adjust to the new price level).

In a true deflationary atmosphere, firms will receive less money and eventually the equilibrium of the economy hits a 'tipping point' where wages will have to go down.

Switzerland isn't there, the price of domestic goods has actually gone up slightly, only the price of imported goods has gone down drastically.

And you're also right about the stickiness of wages - generally firms don't reduce wages, but lay off workers then re-hire at lower wages. Either way the effect at the macro level is the same.

Deflation is defined as a fall in prices. Economists theorise that this leads to a drop in wages and a downward spiral that ends in depression, but actual evidence to support this theory is (as I posted above) lacking.

In practice, Switzerland shows that you can have zero percent inflation for many years (Swiss deflation is recent but lack of inflation isn't) and yet still have sky high wages. Obviously the theory is wrong, as reality contradicts it.