The Problem is Not Deflation, It's Attempts to Prevent It

Mish

Let's investigate the Fed's effort to prevent price deflation.

Here's a Tweet that caught my eye. 

"Problem with deflation is- Why buy anything if you know it will be cheaper in the future.," responded one person. 

Let's investigate that question starting with a look at the CPI basket.

CPI Percentage Weights

CPI percentage weights

Why Buy Anything Questionnaire

Q: If consumers think the price of food will drop, will they stop eating?
Q: If consumers think the price of natural gas will drop, will they stop heating their homes? 
Q: If consumers think the price of gasoline will drop, will they stop driving?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens?
Q: If consumers think the price of rent will rise, will they rent two apartments to take advantage?
Q: If consumers think the price of taxis will rise, will they take multiple taxi rides on advance?
Q: If people need an operation, will they hold off if they think prices might drop next month?
Q: If people need an operation, will they have two operations if they expect the price will go up?

All of the above questions represent inelastic items. Those constitute over 80% of the CPI.  Let’s hone in on the elastic portion with additional Q&A.

Questions for the Fed - Elastic Items

Q: If people think the price of coats will rise will they buy a second coat they do not need?
Q: If people think the price of clothes will drop, will they stop getting dressed?
Q. The prices of TVs and electronics drop consistently. Better deals are always around the corner. Does that stop people from buying TVs and electronics?
Q. If people thought the price of TVs was about to jump, would they buy multiple TVs to take advantage?
Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait if for some reason they think prices will decline? 
Q. If someone does not need a refrigerator, toaster, stove or a toilet will they buy one anyway if they think prices will jump?

For sure, some people will wait for year-end clearances to buy cars, but most don’t. And if a car breaks down, consumers will fix it immediately, they will not wait for specials.

Stupidity Well Anchored

The above questionnaires thoroughly debunk the Fed's ridiculous spotlight on "inflation expectations". 

Yet, how many times have you heard "inflation expectations are well anchored"? 

In reality, Fed stupidity is well anchored. 

The one and only time inflation expectations matter is in a state of hyperinflation when it pays to buy nearly anything and barter it.

No Economic Benefit to Inflation

My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

There is no economic benefit to inflation but there are winners and losers. The winners are those with first access to money, namely the banks and the already wealthy.

The Fed complains about income and wealth inequality but they are the primary source. 

BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

"Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations

Asset Bubble Deflation

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive build up of unproductive debt and asset bubbles that eventually collapse.

Mish

Comments (56)
No. 1-24
Sechel
Sechel

During the industrial revolution we had deflation. country did very well

Sechel
Sechel

I love zero inflation. Makes decision making simpler. Suddenly a financial statement, balance sheet and any other accounting statement isn't full of distortions. I can actually save and plan for future spending too.

Tony Bennett
Tony Bennett

Yet, how many times have you heard "inflation expectations are well anchored"?

...

Setting aside asset bubbles now bursting leading to deflation.

The Federal Reserve policy the past 12 years has been disinflationary. None other than Dick Fisher years ago as Dallas FRB president spoke that keeping rates low AND signaling that would stay low for a very long time (thank you Ben Bernanke) allowed business the luxury of sitting back and see how economy shakes out before committing to capital expenditures. If business knew rates low for only a short time there would be a stampede to lock in rates and commit to expenditures.

Also, remember that low interest rates is a 2 way street. Sure, someone can borrow cheap, but other side of equation (investor) has to settle for less interest income. Less income --> less consumption --> prices held in check.

Kocherlakota (when he was Minneapolis FRB president) gave a speech that low interest rates gave consumers low inflation expectations. Of course, now he is an uber dove and babbles about negative rates.

Sechel
Sechel

But does inflation benefit the government who indexes payment increases to a CPI that is constantly gamed to understate the price level? and which pushes tax payers into higher and higher tax brackets

tokidoki
tokidoki

We all might agree/disagree on the definition of deflation/inflation or what will happen next, but I think we ALL agree that the Fed is stupid.

MATHGAME
MATHGAME

I don't think the FED is stupid ... I think it has goals that are plain for all to see (enrich the richest and have everyone else pay for it one way or another ... privatize assets/profits and socialize debts/losses ... support crony capitalism) and generally achieves them with a focus solely on the present because "In the long run we are all dead” ...

I do think the FED is foolish, unethical, immoral, genuinely evil "in the long run" ...

Nickelodeon
Nickelodeon

I think this write-up is better than your inflation/deflation debate write-up. It asks the right questions and in a Socratic manner which is helpful.

Jdog1
Jdog1

The issue is really natural price discovery is determined by markets, but that price discovery has been manipulated by monetary intervention. Banks have a vested interest in keeping inflation going, and the Fed is simply an extension of the banking system, and works in their behalf.

Carl_R
Carl_R

The only negative to having routine deflation is that people will not be comfortable getting their annual cost-of-living wage decrease (or social security reduction).

Webej
Webej

If consumers think the price of apparel will drop, will they stop getting dressed?

You forgot one.

Webej
Webej

I have a few spare computers, cars and refrigerators sitting around.
I bought them because I feared the price would go up even more and I wouldn't have the money.

Ted R
Ted R

The problem is debt. Debt that can never be repaid. The problem is politicians that refuse to deal with it and make the proper adjustments. Their solution is the keep borrowing. Welcome to 2020.

Scooot
Scooot

Debt & Politics is why a little inflation is targeted.

In a deflationary scenario pressure builds to reduce wages, or at least they don’t rise. People don’t feel so well off as they earn less or don’t grow their income, so the incumbent Government are considered to have done a bad job and are less likely to be re-elected.

As mentioned debt devalues & would cost more to repay, if that was ever the intention.

Bam_Man
Bam_Man

The Federal Reserve exists primarily to create the inflation that allows the federal government to finance itself by selling bonds at negative real rates of interest whose principal will never be re-paid. Simply rolled over in perpetuity (or until the scam becomes too obvious).

Maximus_Minimus
Maximus_Minimus

If you buy a house plus interest on a 30-year mortgage, you will never spend anything close to that for the whole life. That's enough math to understand the fraudulence of the CPI chart. Then again, CPI is not about math, but manipulation.

Jovial
Jovial

I've always defined "economic progress" as "getting what we need and want for less labor". That's fundamentally deflationary.

Jdog1
Jdog1

The negative to inflation is that it is robbery. It robs the value of earnings and savings to make money for nothing for banks and other institutions which benefit from inflation without production.

Gman007
Gman007

New credit growth falls below interest payments

Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.

~Kenneth Boulding, economist

SunnyvaleCA
SunnyvaleCA

I have to take issue with your statement: "There is no economic benefit to inflation."

I think a better statement is: There is no NET economic benefit to inflation — some are winners at the expense of those who are losers.

purple squish
purple squish

"Why buy anything if you know it will be cheaper in the future?" I don't know, maybe because we aren't the immortal elves of Rivendell and we get old and die someday? The "people will always wait till it's cheaper" crowd seems to miss the point that present goods are more valuable than the same goods at some future time, full stop. You can (pretend to) know for certain something is going to be cheaper eventually, but still make a rational decision to get it today if your discount rate is steep enough. Even more frustrating, half of these people crapping themselves about deflation seem to think that humans are rational enough to forego spending on everything indefinitely to save a few pennies, but are simultaneously so irrational that we need nudges in the right direction for any important decision so we don't get bamboozled.

BrainDamagedBiden
BrainDamagedBiden

Thanks Mish. Some good food for thought.

I think one needs to differentiate between debt deflation and deflation from productivity. The later is good the other bad

I don't think debt deflation will be pretty, but it's much better than printing up $$s to bail out the crony capitalist and shifting the cost onto the general population. Negative consequences need to occur when business make poor decisions; otherwise, they'll continue to behave like scoundrels.

magoomba
magoomba

Endless growth is the morality of a virus cell.

tomhtu
tomhtu

Well i don't think your questions are very realistic and quite nonsensical Mish. They don't consider the secondary effects of deflation if someone loses their job or savings/assets due to deflationary environment. Also you assume everyone in America is in your economic situation.

Q: If consumers think the price of food will drop, will they stop eating? no but they will eat lower priced items and stretch their dollar
Q: If consumers think the price of natural gas will drop, will they stop heating their homes? nope. they will stop paying and move to "THAW" and other public assistance programs
Q: If consumers think the price of gasoline will drop, will they stop driving? Maybe. They might be out of a job and will definitely curtail discretionary driving
Q: If consumers think the price of rent will drop, will they hold off renting until that happens? yup if they lost their job
Q: If consumers think the price of rent will rise, will they rent two apartments to take advantage? nonsense question
Q: If consumers think the price of taxis will rise, will they take multiple taxi rides on advance? nonsense question. I guess I'll have to walk instead of taking a taxi
Q: If people need an operation, will they hold off if they think prices might drop next month? most people yes. rich people no
Q: If people need an operation, will they have two operations if they expect the price will go up? nonsense question

Q: If people think the price of coats will rise will they buy a second coat they do not need? I guess I'll have to make do with the coat i have and put off getting a new one. especially if i lost my job or savings in the stock market
Q: If people think the price of clothes will drop, will they stop getting dressed? no but they will reduce spending or buy off brands and make do.
Q. The prices of TVs and electronics drop consistently. Better deals are always around the corner. Does that stop people from buying TVs and electronics? yes if they lost their job and don't have a choice anymore.
Q. If people thought the price of TVs was about to jump, would they buy multiple TVs to take advantage? nonsense question
Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait if for some reason they think prices will decline? yeah if they dont have a lot of money like most of america
Q. If someone does not need a refrigerator, toaster, stove or a toilet will they buy one anyway if they think prices will jump? another nonsense question

GoingEast800mph
GoingEast800mph

The Fed...and by extension the U.S. government...has one and only one interest in creating "manageable" inflation, but it is not a small one: Under deflation, U.S. national debt becomes much harder...not easier...to pay off than under inflation. Literally, not figuratively, the entire (current, debt-ridden) system blows up if long-term/severe deflation takes hold. Which it is.