Deflation By Paul Krugman

Paul Krugman, a well-known economist, wrote an opinion piece in the New York Times (Why Is Deflation Bad? 2 August 2010).

He basically gave three reasons:

1. When people expect falling prices, they spend less now, and obviously they therefore don't borrow. Producers therefore don't borrow to build more factory production capacity. They have to pay off the "higher price" loans taken today with "lower selling prices" of their goods sold in the future.
   
   
2. Falling prices worsen the position of debtors by increasing the "real" burden of their debts. This feeling of increased burden will force them to cut spending. Therefore the economy will go down.
   
   
3. In a deflationary economy, wages will have to go down. Due to the "downward nominal wage rigidity", wages can really only go down with mass unemployment.
   
   {Above paraphrased by me, do read his full article at the Link}
   

When we see this kind of opinion piece, we must realise it is only AN OPINION! We must not simply accept what he says just because he is "a well-known economist". Basically I am saying, he may not be right!

Here is my opinion (may only be worth 2 cents!):

1. Firstly, do realise why they (ie americans) are so concerned about deflation and inflation. They always say that the consumer spending forms 70% of the economy (i.e. the GDP). Any threat of a slowdown in consumer spending is a threat to the economy (ie the Big Businesses, the stock market, the rich people).
   
   But they never say that its bad for the consumer to spend via debt (ie borrowing; from the Housing ATM, credit cards, personal loans from banks etc...). They just simply say that borrowers (consumers) should be wise and not get into trouble (this is like telling people they should not be obese).
   
   Basically, do realise that economists like Krugman only look at the situation from the business people point-of-view. If questioned, they will simply say that businesses employ all of us, so what's good for them will be good for us. I leave it to the discerning reader (if any) to reply to that. I will just ask; Out of $1, how much do the business people want to give to us (ie, how efficient is this)?
   
   
2. With the above in mind, we can re-look at his three points in a different light. We can look at it from the view of the normal man-in-the-street.
   
   What is wrong in spending less? What is wrong in having less (or no) borrowing? What is wrong in having the price of things keep dropping in the future?
   
   Note the point about the producer not borrowing to build more factories. The WHOLE BUSINESS MODEL is to pay off borrowings with less valuable future money (ie we must have inflation - things will cost more to the consumers, but better for the businesses who are the borrowers).
   
   Those of us who are older will remember the VCR costing $3000 each when they first came out. They became CHEAPER and DVD players (ie the current technology) are $100 each. Did the cheaper things reduce or increase the number of consumers?
   
   It is true that dropping prices cause many manufacturers to go out of business to be replaced by new manufacturers able to produce the new things at lower costs. So those who complain (and want the status quo) are alway those "current" manufacturers.
   
   SO THE CURRENT BUSINESSES NEVER WANT DEFLATION.
   
   
3. In the search for more and more sales (higher growth and profit), the poor consumers are encouraged to borrow for instant gratification (why wait till you are old to enjoy a Mercedes!).
   
   So, on Krugman's second point, what's wrong with borrowers reducing their borrowing? Consumers need to learn more on Deferred Gratification.
   
   
4. His third point is that wages will go down (Oh, what a frightening prospect! You mean no more increments? You mean there will be "de-crement" instead?).
   
   If there is deflation, then things will become CHEAPER, so your present wage will buy you more things! And even a "de-crement" may not mean your standard of living will drop (remember that the cost of living is dropping as well).
   
   
5. The mass unemployment has nothing to do with deflation as such. It is the TRANSITIONARY effect from the Inflation Model to the Deflation Model.
   
   What this means is that in the change from the current inflation to deflation, a lot of businesses (even individual consumer borrowers) will go bust. So unemployment will shoot up until the NEW businesses start up. So there will be suffering everywhere.
   
   
6. So, nobody (not even I) wants to have this transition (change) and the attendant suffering.
   
   So, the question is, can the current model continue?
   
   Or, now that the current model is in trouble, should we try to rescue it (bailouts, stimulus, etc...)?
   
   Or, will all these rescue efforts, in fact, make the eventual crash even worse (i.e. the medicine gets more bitter as we further delay taking it)?
   
   
7. These rescue efforts (bailouts, stimulus, ...) include reducing the interest rate. But the reduction in interest rate for the borrowers automatically reduces the interest rate given to the savers (that's why your saving account at your local bank earns you less than 1%)!
   

All this is only my opinion, and I encourage everyone to research and form their own opinion. Good topics for research (the wonderful World Wide Web) include Keynesian Economics (Are they applying ALL of his theory or ONLY HALF), Austrian School of Economics, Ludwig Von Mises, ...