Friday, 28 February 2014

Deflation is not benign

In an economy where the money supply depends on the production of debt, deflation can never be a good thing. In fact as any cyclist can tell you, deflation means you aren't going anywhere.

More on this here.

7 comments:

  1. Not on topic to your post: but I have a question. Why is it that government interest payments as a percent of GDP are not quoted as a figure for understanding the effects of debt levels (flow vs flow scenerio). And why do we not see popularly discussed any theories about why this value may change over time (its velocity)?

    Maybe you'll say such a figure is unimportant (I have no idea myself). But I think it would be a lot easier for the public to understand, and to frame policy choices about, than the popular debt/gdp framework that has provoked much unenlightened discussion.

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    1. I prefer to compare interest cost to gdp, rather than debt/gdp. As you say, it is better to compare like with like. Debt/gdp compares stocks and flows and therefore needs to used with caution, I would say.

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  2. Regarding the problem of deflation increasing the value of outstanding debts. Hypothetically that could be overcome if the credit system was changed and so the value of the debt was constantly recalculated by factoring in the inflation rate, if in reality the money supply effect on prices could really be measured accurately enough to do that though.

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  3. > Frances

    considering your post would you agree that paying off debt increases the value of money, and so not paying off debt decreases the value of money the value of money, and so defaults on debt are inflationary.

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    1. No, I would not. Defaulted debts are written off and therefore destroy money in exactly the same way as if they were paid off. In effect, the lender pays the debt from profits. The effect is therefore contractionary. Additionally, widespread debt default destroys the value of assets, and that also has a contractionary effect - see Irving Fisher on this.

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    2. So those debts are paid from commercial lender profits. If however the Central bank is the Lender, how is that scenario handled.

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