22 August 2010
Deflation

The argument against deflation (if I’ve got it right) is that people will hold on to their money in the expectation of even lower prices in the future.  In other words that if they wait long enough they will be able to buy more.  What is the difference between this and having a positive real interest rate?

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  1. Isn’t a positive real interest rate - large enough and held over a long enough period, merely a means by which a general deflation can be brought about?

    I don’t think there is an argument against deflation or inflation per se - both would happen all the time to some limited degree under conditions of market competition for currency. It is only when we are all forced into using one currency that variations in the interest rate become a serious problem.

    Posted by mike on 25 August 2010 at 01:06pm

  2. Presumably with deflation you can just stuff your money under the mattress and wait until you can buy more.  Whereas interest presumably comes from lending savings which buys capital and causes growth.

    Except that the Bank of England can apparently *set* an interest rate, which doesn’t make any sense by my model.

    Posted by Rob Fisher on 25 August 2010 at 05:54pm

  3. Actually, delete my second paragraph. I don’t think it affects the argument.

    Posted by Rob Fisher on 25 August 2010 at 05:57pm

  4. “Whereas interest presumably comes from lending savings which buys capital and causes growth.”

    Well it may come from savings if the lending is done by a private commercial bank, but when it is done by a central bank - which I assume is what was being referred to here - then that isn’t going to be the case at all.

    Posted by mike on 25 August 2010 at 06:41pm

  5. No, I meant commercial banks.  The idea being that if there is deflation and you hold on to your money you end up richer.  If there is a positive real interest rate and you hold on to your money (in a bank) you end up richer.

    But, as Rob points out with deflation you’re not lending it out.  Unless, of course, you are.

    Posted by Patrick Crozier on 26 August 2010 at 06:32pm

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