Monday, November 3, 2014

Is Deflation Good for Anyone?

There is talk again of deflation - a decrease in price levels in an economy.  Europe, due to misguided austerity, is facing deflation and it is already present in some of the bailout countries like Greece and Spain.  Japan has wrestled with deflation for almost 20 years since its real estate bubble burst.

Why is deflation bad?  Simply put, people don't buy goods and services today because they will be cheaper tomorrow, so demand goes down, which generally causes prices to go down further and unemployment to rise, and it becomes a self-feeding monster.  Assets like real estate are a special problem as they are leveraged (mortgaged) and the value of the asset keeps falling while the debt must still be repaid, and the real cost of the debt rises with deflation.  Europe and Japan are trying to stop their deflation cycle before it gets worse.

Generally, you want some inflation, but not too much, so people consume, and their savings return is higher than the inflation rate, and demand is increasing.  Hopefully you get full employment, happy people, etc etc.

Does anyone benefit from deflation?  I would argue that no one benefits, because an economy or society that is experiencing decreasing demand, loss of value of asssets like housing, and increasing unemployment is not a pleasant society.  However, retirees are better off than many other members of society as they have liquid savings which will go further in terms of buying power and they generally do not have leveraged assets like mortgaged houses that are decreasing in value.  However, retirees are just relatively better - "the tallest pygmies" in the words of an old boss of mine.

No comments:

Post a Comment

Comments are not moderated prior to posting. Mark