Governments lie about the inflation price and benefits from it , so , it is no surprise whenever they talk against deflation (for the purpose of this article, assume pumpiing as a general increase in costs and deflation as the opposite), which would be good for customers and the economy, but bad for the government.
(While Austrian Economists define inflation as an increase in the supply of money, the net effect of inflation is an increase in asset prices, as well as a distortion of the structure of manufacturing. )
Costs fall in a scenario in which the currency is not inflated and, therefore , there are more eco friendly investments and increased efficiency. In an economy with little if any government intervention (at least few monetary interventions plus few regulations, government investing and taxes), there are more long-term investments (capital investments, for example), which increase the economy’s productivity. In a deflationary economy, the purchasing strength of money tends to increase, because there is no monetary inflation by central banks and prices tend to fall. Consumers can buy more products and services and companies have higher profit margins.
But governments do not like deflation, they are the most delinquent entities. Inflation is beneficial in order to borrowers, as they repay loans in a currency with lower purchasing power than when they took the loan. It really is even more beneficial to the government as it can expand the money supply to pay the debt. Furthermore, pumpiing is good for the government because it creates an apparent economic growth, which will eventually be wiped out by a recession. But , as this can take a few years, the immediate incentive for the incumbents would be to take advantage of this instrument.
Two typical quarrels given by governments against deflation are as follows:
“ Deflation Will Cost Entrepreneurs”
The reasoning behind this particular statement is that, if prices fall, entrepreneurs will market products and services at lower costs than the cost to produce all of them. However , this statement will not hold if we consider the idea that, in a deflationary economy, the particular currency’s purchasing power tends to increase. So even if business owners get less money (nominally) than what their products cost, in real terms, they will still make a profit. In addition , the prices of the inputs used in production will also fall in a deflationary economic climate.
Therefore , by using productivity and management associated with expenses that every company should have, it is possible to sell the products with low prices, but with the same and even higher profit margin than in an inflationary environment. (Note: even if we disregard this gain in purchase power and lower production expenses, it would be possible for the business owner to protect himself through future contracts). And, precisely mainly because prices get lower, customers buy more products and services (without going into debt) and companies profit more due to the decrease in costs that occurs thanks to deflation. This is particularly the case in the technology sector. Computers today are cheaper and much better than they were 30 years ago. Mainly because prices got lower (due to increased productivity), consumers began to buy more, which usually increased the industry’s revenue, which brought more purchases and higher productivity.
“ Consumers Will Postpone Consumption under Deflation”
The reasoning behind this particular argument is that if costs are constantly falling, nobody will buy the products and services due to the fact individuals will always expect prices to go down. This also will not make sense, as there are always services and products that people have to purchase (such as food and medicine). Nobody starves themselves to dying or does not purchase medicines because a year later they are cheaper. Only when the product or even service is expensive do consumers postpones consumption, that is what occurs with continuous inflation created by central banking institutions. Furthermore, people tend to have a high time preference (hence, they wish to satisfy their demands in the present, not in the future). If they can afford to buy what they want, they won’t hesitate.
Consequently , deflation has several benefits, not only for consumers, but also for business owners. A deflationary economy can make industries more profitable and more efficient (producing cheaper and better products and services). Also, deflation has two other benefits:
The Economy Becomes Much less Indebted
In a deflationary economy, customers would tend to buy products and services in cash rather than by going into debt. Consequently , less money would be directed toward interest payments for usage. The incentive to save would be higher, which would lead to a lot more investments, which would lead to higher productivity, which would lead to less expensive and better products and services, which would lead to higher profits, which may lead to more incentives to get investments. It’s a beneficial cycle for the economy.
Furthermore, the current scenario of zombie companies would not occur in a deflationary economy, as the incentive would be for savings plus investments in productivity, not indebtedness. The central bank (if it existed) would not inflate the currency, nor it would control interest rates and expand the money supply (hence, there would be less malinvestment plus companies would be more efficient, as they would be more subjected to the profit and loss mechanism). Therefore , inefficient companies will be quickly eliminated, leaving sources to be used by potentially more effective companies. There would be less substantial waste of resources within unsustainable developments. Banking exercise would also be healthier, because there would be more loans for investments (which, in general, would certainly create value that would counteract interest expenses) than meant for consumption.
Products and Services Would Be Cheaper, Better, and More Varied
Assuming the federal government would significantly decrease investing, taxes, and regulations (in addition to not expand the money supply) a deflationary economy would generate greater diversity of products and services, as competitors (or potential competition) might tend to be so high that lowering prices and improving product quality would not be adequate for companies to survive. They would have to invest in product diversity to give consumers more choices, meeting increasingly specific demands and being able to sell to varied groups of consumers (that have different desires and needs). This is already happening in the technology sector and would occur at an even greater intensity in other sectors as well within a deflationary economy.
Historical Examples of Decrease
A good example of deflation occurred in the US within the nineteenth century. Between 1800 and early 1900s, the price index dropped by 50 percent (from 150 to 100) . “ Despite” this deflation, the nineteenth century was designated by great economic growth in the US (an increase in the particular productivity of industries plus falling prices). This is exactly what happens in a deflationary economic climate (or, in this case, one that seems towards deflation). From 1815 to 1914, the US is at a gold standard (read pp. 89– 92 of this book ), which is deflationary.
There were only a few inflationary periods, such as the Civil War in the 1860s. According to Patrick Newman ( p. 497 ), during the Municipal War, Congress established the national banking system. Each state and national banks were able to pyramid credit on the same set of lawful money reserves through the use of interest paying interbank deposits. This credit development led to a depression within the 1870s (1873– 79), since explained by the Austrian business cycle theory .
The credit expansion was still happening in the depression period (which, according to Newman, must be considered between 1873 plus 1875 because the data during the time were based on nominal collection and there was little access to aggregate economic information) plus signs of contraction began to appear, resulting in bank runs, which led to a credit crunch. In addition , there were no fiscal or monetary stimulus during the depressive disorder. For this reason, according to Newman, the particular recovery was faster, because the economy was able to reallocate resources efficiently.
Singapore is also a good example. Although it is not really in a gold standard, its exchange rate policy is less inflationary than the floating exchange rate policy (adopted by most central banking institutions, including the Fed and the Western european Central Bank).
As of 1981, the CONTUDO (Monetary Authority of Singapore), Singapore’s central bank, started to interfere only in the swap rate ( as stated by Leandro Roque in 20: 11 ), controlling the value of the Singapore dollar (SGD) in relation to a basket composed by the foreign currencies of the main economies from the world, increasing and reducing the monetary base via purchases and sales of assets, respectively. The goal is to have a currency that continuously appreciates against the others.
Therefore , the particular MAS does not act simply by setting a target for the interest rate, leaving it to become mostly determined by the market. Thus, investments tend to be more sustainable in the medium and long term (since they tend to be financed simply by savings). This contributes to sustainable economic growth, with less intense recessions. The result was that between 1982 and 2005 the SGD was the currency that lost less purchasing power on the planet, surpassing even the Swiss Franc (CHF) .
Hence, the inflation rate remained low (increasing considerably only in some brief periods). At some points, there was actually deflation (inflation rate beneath 0 percent).
When it became independent through Malaysia in 1965, Singapore adopted higher economic freedom, which resulted in the surging of private companies that were very aggressive in the global market, and to a high standard of living . The federal government adopted a policy of lower public spending and reduced taxation, almost nonexistent paperwork, and few regulations. The less inflationary policy of the MAS is one of the main (if not the main) aspects that contributed to Singapore’s performance.
Deflation is only bad for the government. In a deflationary economy, it cannot tax people not directly via inflation and it aint able to use monetary policy in order to artificially boost the economy and get votes before there is the inevitable recession. Consumers (mainly the poorer) and entrepreneurs are the ones who benefit from decrease (due to lower prices plus larger profit margins, respectively).
To learn more about decrease, watch this lecture by Philipp Bagus .