# Thread: What's wrong with a little deflation?

1. Originally Posted by ptgatsby
Financial decisions are made as you said. However, not all things become equal. If a company had a lot of cash on hand, and the relative cost of their production is decreasing, they can simply wait before buying new production (and thus get more of it). This would be equivalent to "money market rates" to some degree - but keep in mind that inventory and the like gets progressively less valuable vs. the cost of production too.
Ah. I see where I made my mistake...it was in modeling the deflation of production costs.

Saying that the investment will save some constant nominal p percent of the initial investment is not a good assumption.

It is proabably more accurate to say on the ith period, the initial production investment will only save p(1-d)^i.

Then for the expenditure, our future worth is -1 + p*sum_from_i=1_to_i=x_of[(1+c)^(x-i)(1-d)^i] = (p(1-d)/(c+d))*[(1+c)^x-(1-d)^x]-1

So we need [(1+c)^x+1](c+d)/[(1-d)[(1+c)^x-(1-d)^x]]<p

So deflation does make it less attractive for effeciency improvements in this model, and much more so for larger values of d. This may or may not be offset by lower yeilds from the alternative investment (in the money market for example), and I didn't add what deflation would do to yeilds.

Originally Posted by ptgatsby
As such, any investment actually has declining value in real terms, so unless you can convince labor and the like to take progressive salary costs, it's not feasible (this was the "sticky wages" issue.) It's possible to balance it out on paper, and in theory it does (and I think the normal economic view is that it does balance - over years and years.)
I still don't understand this. Wouldn't sticky wages give more incentives for firms to reduce manpower needed to acomplish something? (either in terms of fewer workers or fewer hours per worker).

Originally Posted by ptgatsby
Ask yourself if you would buy a house if deflation was about 4% per year. How much should the bank charge you in interest? (Keep in mind your wages are deflating at 4% as well, in theory.) Another way to think about it is - how much cash do you need to rent in perpetuity if deflation is 4% (same as a perpetuity, in effect, but now I *don't* need to invest it!)
I don't think I understand this either. Wouldn't it depend on the specifics of the property and rents in the area, and whether or not you'll take a loan to buy the house? Are you saying that we anticipate rents are going down, so signing up for a mortgage at a particular time would fix payments that you'd rather not be making?

Originally Posted by ptgatsby
Competition and constraints, normally. But I know the finance side goes, I don't know how it affects the monetary/economics side much. That makes the "right" amount of research, given that competition and constraints are present, dependent on if it is expected to make you more efficient (than your competitors) despite constraints (like labor costs, new production, etc.)

Research, as far as I know, is considered under-produced by the market in general... and I know that one reason for increasing the monetary supply is to offset this kind of deflation and keep investment/consumption active.
So, is it a cause-effect thing? The "good" deflation has "good" things as the cause (including investment in efficiency), so that's why that deflation is good, even though the deflation itself doesn't cause anything good in return.

2. I don't get it.

I think the barter system is pretty cool, and it's a system that I fully comprehend and approve.

K, bai.

3. Originally Posted by ygolo
I still don't understand this. Wouldn't sticky wages give more incentives for firms to reduce manpower needed to acomplish something? (either in terms of fewer workers or fewer hours per worker).
It would give incentive to reduce manpower - but the people that produce, consume. Less consumption, less production, less work, less consumption... Reducing manpower is akin to saying "reducing demand". That's why the concern is that 'deflation' will translate to the lockstep effect of losing national income (ie: people earning less, buying less, producing less, people earning less-> cycle). There is no incentive to produce more - the market can't absorb it.

Likewise, excess labor means efficiencies are less important, just as less demand reduces capital investment.

I don't think I understand this either. Wouldn't it depend on the specifics of the property and rents in the area, and whether or not you'll take a loan to buy the house?
Maybe my line of thought is clearer if we talked about it between two people. Lets say that I want money now, and am willing to borrow it from you. You have extra money that you wish to earn a higher return on, since it is excess and you don't desire to consume it.

In a deflationary environment, it means that the money you already hold will "go up" by x% a year. So, by virtue of this, you already would gain at least x%. This lowers the incentive for you to lend me the money - you have a risk free premium already. It's like saying that you have your money in a real return fund, risk free, of 4% - would you lend me the money at decent risk with a real return of 6%?

The flip side of this is that if I borrow the money from you, if I spend it in the present, I will progressively owe you "more" money due to deflation, even if you charge no interest. This is because the cost and income of everything is going down, and as such, paying you back the amount in the future means it is relatively more. This leads to;

Are you saying that we anticipate rents are going down, so signing up for a mortgage at a particular time would fix payments that you'd rather not be making?
That's certainly one thing. But it's more than that - because the mortgage stays the same but the value of the home goes down. Now, the consumption model is more complicated because rents and mortgages involve opportunity costs...

So, in the example above you gave me money. Lets say that it was a mortgage. Now, you get to charge me a rather low interest rate - lets assume that it's slightly over 2% real terms. You are effectively earning 6% then, but for the sake of the mortgage, it doesn't matter.

I am currently renting at \$1000 and go to buy a place at \$250,000. In ten years, I would owe you ~305,000. My home would be worth ~170,000. Rent would be ~\$675. The rental illustration is important - lets say that I bought the home as an investment. With shrinking rents... well, eventually it won't be feasible to support the lending. The rental example applies to all "return on money". You could lend me the money, or you could buy the house to gain a return on the money. Unfortunately, buying the house nets you a -4% return on capital, and a -4% return on income stream.

The short of it is that I have no incentive to turn your money into an investment - they reduce in value. You have little incentive to lend to me, because I am not going to be paying interest in deflating dollars - that's horrendously expensive, from an investment point of view. What it would do, however, is cause you to hold on to your money, even if you didn't invest it, just as I would want to rent rather than own. And saving money has high immediate rewards (that is, saving 10% of income now is worth a lot more than 10% in the future).

So, is it a cause-effect thing? The "good" deflation has "good" things as the cause (including investment in efficiency), so that's why that deflation is good, even though the deflation itself doesn't cause anything good in return.
As I understand it, yes. Deflation in and of itself isn't terribly good. It just so happens that the deflation that comes from efficiencies is good on its own and while it is better to offset that deflation with monetary growth to encourage a stable money supply, it has very different characteristics than an actual monetary contraction (long or short).

4. Originally Posted by CaptainChick

I don't get it.

I think the barter system is pretty cool, and it's a system that I fully comprehend and approve.

K, bai.

barter is great, but not very practical on a greater scale. It is also difficult to barter somethign you do not possess, although indentured servantry might work a lil. It seems like hte concept of system of interest exists mainly to funnel money upwards over time.

5. Originally Posted by ptgatsby
It would give incentive to reduce manpower - but the people that produce, consume. Less consumption, less production, less work, less consumption... Reducing manpower is akin to saying "reducing demand". That's why the concern is that 'deflation' will translate to the lockstep effect of losing national income (ie: people earning less, buying less, producing less, people earning less-> cycle). There is no incentive to produce more - the market can't absorb it.

Likewise, excess labor means efficiencies are less important, just as less demand reduces capital investment.
What you are describing is economic contraction, it seems. I undeterstand that deflation often comes along with contraction. But there are many examples in history with economic expansion accompanied with negative inflation rates (Industrial Revolution, 1920's in a few countries)

Also, for my firm, for my own self interest, wouldn't I want to produce things with less man-power? and wouldn't I want to target markets with inelastic demand?

People will always need to eat. They will always need some amount of heat and energy. We can conserve to some extent, but at some point we cannot demand less. Though we can always look for these things at lower costs.

There are two questions then:
1) What ends this cycle of contraction during a deflationary period?
2) Why doesn't the "good" deflation also create an economic contraction?

Can you imagine another mode of the economy where people only produce goods with inelastic demand at cheaper and cheaper prices? or goods for what is necessary to make advances of this sort at cheaper and cheaper prices? The economy is increasing in real GDP terms, but deflation is still there and it doesn't matter what happens to the nominal GDP.

Consider the example from 1869-1896, Real GDP grew 4% per annum while price changed -1.8% per annum. This was the direct result of technology (The Industrial revolution).

The particular rental examples make sense to me, and the basic incentives to not borrow or lend make sense in that context (and presumably this is the reason for continued monetary deflation). I had taken these sort of decisions for granted. But I don't believe that all investments are equal.

Technology is a very different sort if thing. We are actually changing the production rate in a sustainable manner with technology. One can even imagine a state of the world where technology provides for all needs/wants without anyone needing to do work--one distopian vesion is given in "The Matrix."

This is a completely made up example, but I don't know why something similar couldn't happen.

Lets say I am a custom widget packager and it costs me \$0.20 per widget to package right now. At -2% inflation, it will cost me \$0.196 per widget next year, \$0.192 the following year, \$0.188 the year after that.

Lets say I'm selling the widget packaging service at \$0.60 per widget right now. Assuming the same -2% inflation, I will get paid \$0.588 per widget next year, \$0.576 the next year, and \$0.565 the year after that

Assume, I package 100000 units each year, and I have an cash account that pays 3% nominal interest.

Let's examine two senarios in terms of what we can do with \$3000.

Scenario 1: We just keep it (and our profits) in a cash account. After the 4 years described we have ~\$166K in 4-year-from-now-dollars.

Scenario 2: We upgrade to a modern packager droping the cost by a factor of 10 by using all \$3000.

It now costs me \$0.02 per widget to package right now. At -2% inflation, it will cost me \$0.0196 per widget next year, \$0.0192 the following year, \$0.0188 the year after that.

Let's make the senario a little more bleak by saying that my lay-offs, as well as others makes the price inflation -8% per year. Then the widget packaging service will pay \$0.60 per widget right now, \$0.552 per widget next year, \$0.508 the next year, and \$0.467 the year after that

In this senario we only have our profits go into our cash account. We will end up with ~\$215K in 4-years-from-now-dollars.

So despite the deflation, the investment still makes sense. From the perspective of a firm, investments can still make sense if they are good enough.

It's weird, I know I am arguing a minority position among economists (minority among both liberals and conservatives), but I am trying to wrap my mind around the Neo-Keynsian view that seems to prevail. I think the hard-currency vs. central banking discussion you and Laterelus had is germain to my misunderstanding, but I don't even have a vague idea how it fits in.

6. Originally Posted by ygolo
What you are describing is economic contraction, it seems. I undeterstand that deflation often comes along with contraction. But there are many examples in history with economic expansion accompanied with negative inflation rates (Industrial Revolution, 1920's in a few countries)
You're right - it doesn't have to happen. But in neither of those cases did the money supply contract in and of itself - that's why I asked Laterus about how the gold supply contracted. Strong deflationary periods - that is, tangible obvious reduction in money supply, not a period where goods and services produced exceeded the existing demand for money - are notably different than an rapid increase in good and services provided.

In the case where we can produce more, "demand" hasn't changed. People are still earning the same amount, and can buy more. When there is an actual contraction, it tends to lead to a reduction of income - that is, people don't have money to spend, and by not spending they put others out of work.

Also, for my firm, for my own self interest, wouldn't I want to produce things with less man-power? and wouldn't I want to target markets with inelastic demand?
You do, of course. However, the ability to do that isn't just hand waving. At best, it means you just need to buy new machinery - a capital investment, which costs money. So, if you want to produce 10% more goods, what is going to be cheaper - buying new machinery (that wasn't profitable to buy at full demand), or hiring workers for cheaper than existing workers (since the unemployment/etc is higher).

And given a contraction, in either case, you will produce more and have to lower your price, as existing demand doesn't exist.

Efficiencies don't happen in a vaccum - they require both capital and it needs to be the most efficient way to produce something. In nearly all cases, if the efficiency hasn't manifested itself at full capacity, it won't manifest when under-utilised.

People will always need to eat. They will always need some amount of heat and energy. We can conserve to some extent, but at some point we cannot demand less. Though we can always look for these things at lower costs.
To eat, we could employ 3% of the population, roughly, plus probably 10-15% in support, for a long period of time. What would happen is that the 80% unemployed would have no money to buy the food, leaving the 3% unpaid - they can consume the food, but since nothing else is being produced, the money has no value to them.

That's the impossible extreme example of the issue - the system is about how resources get distributed, and the bottom line is that people only trade when profitable. People with no money and no work don't get anything, including food. And it is entirely possible that people simply cannot find work, because no one will pay. The farming example is exactly that - it is a return to the agricultural age. As each person is unable to find work, they "grow" their own food - excess labor defeats the purpose of machinery, since it makes no sense to have the machinery infrastructure if ~80% of the population can't use it, and need to farm to stay alive. (The "80%" more or less means huge economic contraction over years and years, literally returning to pre-industrial times.)

The economy has no safety net. It's more likely that economic shocks would lead this, but an interactive effect can cause people to literally be unable to pay rent or buy food at the market price. It's unlikely, because in general people will work any amount of hours to get food, but... it's not unheard of. Hard to believe because we are very advanced, and I would say that the probability is so low as to not be worth considering... but the market does not take into account "need to eat". Pricing mechanisms are not friendly to needs.

(None of this should be taken as a scenario, it's ridiculous. Aggregate demand should restore itself long long before anything like this could happen. And it would require a serious social breakdown too. But... the great depression itself wasn't that far off - not to the food point, although it does illustrate how people simply couldn't find work and were unable to afford food.)

1) What ends this cycle of contraction during a deflationary period?
Good question - I'd need an economist to tell me what they think. That way I can be skeptical over that too

(All jokes aside, the problem here is financial, I think. The destruction of loans, due to the monetary system, is deflationary because of the reserve system. Each loan that is taken off the books at a bank contracts the money supply, leading to both bank failure and monetary contraction. So, more of an interactive effect than any one thing in particular.)

2) Why doesn't the "good" deflation also create an economic contraction?

Can you imagine another mode of the economy where people only produce goods with inelastic demand at cheaper and cheaper prices? or goods for what is necessary to make advances of this sort at cheaper and cheaper prices? The economy is increasing in real GDP terms, but deflation is still there and it doesn't matter what happens to the nominal GDP.
All that is required for good deflation is an economy with contraints, notably labor constraints. High utilisation = high income = high demand... and so it is a hot economy. Deflation simply works against that - your scenario below highlights that it is possible. But everything is at the margin, and there is simply less of it (often to the point of recessions) during deflation.

Innovation, itself, happens no matter what the overall economic conditions are - it just happens much slower, as does investment, in deflationary periods. When it doesn't happen much at all is during an economic contraction. So, if you get into defaltion -> lower investment/etc -> less income -> less demand -> contraction, then things start going bad.

Consider the example from 1869-1896, Real GDP grew 4% per annum while price changed -1.8% per annum. This was the direct result of technology (The Industrial revolution).
I'm still researching this period. My impression is that the answer to this is not as simple as "the industrial revolution" - there were monetary issues left over from the war, and government policies on the monetary side. In addition, this period was not smooth - there were recessionary periods. So, huge amounts of government spending, specie acts, recessions/expansions in rapid succession... In my non-professional opinion, it wouldn't fall outside of the aggregate demand theories at all.

However, there is no question that the advances made here caused 'good' deflation. But there still seems to be a battle between them. The improvements caused a lot of over-capacity utilisation, which drove everything forward...

So despite the deflation, the investment still makes sense. From the perspective of a firm, investments can still make sense if they are good enough.
That's fine. Rerun the scenario at a marginal improvement of 5x, 2x, 1.5x... and then rerun the same simulations with inflation It's possible to come up with scenarios that work, but it is very very rare that the gains are that significant - it tends to be progressive, with starts and leaps as the technology builds up to something that would be a net benefit.

But also keep in mind that while you model, people do not readily accept pay cuts... and that while it can work for you, if you and everyone else lay off people in sufficient quantity, you are also laying off people who buy your widgets. In an economy, ideally, those people would find work - but in situations where there is no demand for them (not systemic to deflation in general, but is indirectly related) you would sell progressively less. That means that labor might drop much faster than 2%, but if it does, it also means you can charge less (this makes your capital investment relatively more expensive, and new capital investment less likely.)

I don't disagree that it can be possible, only that systemic deflation is less ideal for capital investment. And in a deflation/contraction mix, there are huge dangers across the board. Money hording is the normal way of life, and investment goes to nearly nil. In an inflationary environment, it's "find something that will gain you money", even in a bad economy, but in a deflationary environment, it's "don't do anything to lose money" since you are already gaining while safe.

7. Originally Posted by ptgatsby
You're right - it doesn't have to happen. But in neither of those cases did the money supply contract in and of itself - that's why I asked Laterus about how the gold supply contracted. Strong deflationary periods - that is, tangible obvious reduction in money supply, not a period where goods and services produced exceeded the existing demand for money - are notably different than an rapid increase in good and services provided.

In the case where we can produce more, "demand" hasn't changed. People are still earning the same amount, and can buy more. When there is an actual contraction, it tends to lead to a reduction of income - that is, people don't have money to spend, and by not spending they put others out of work.
That's interesting. Then what happened in Japan between 1994-2002?

It is not a stellar growth in Real GDP, but real GDP grew 1.3% per annum while prices changed -1.0% percent per annum. The following source claims it is not a depression.

source: https://dspace.lib.rochester.edu/ret.../pps030206.pdf

I realize this is coming from a monetarist foundation (this was the paper that sparked my question in the first place). This paper actually argues that the ideal inflation rate can be negative. Does it come down to somehow always forcibly inflating the money supply?

Also, even during the late 19th century, there is a notion of the general glut.

I'd like to trace the various models to their basic assumptions, because there seems to be plausible sounding arguments with data to back that go both ways.

Originally Posted by ptgatsby
You do, of course. However, the ability to do that isn't just hand waving. At best, it means you just need to buy new machinery - a capital investment, which costs money. So, if you want to produce 10% more goods, what is going to be cheaper - buying new machinery (that wasn't profitable to buy at full demand), or hiring workers for cheaper than existing workers (since the unemployment/etc is higher).

And given a contraction, in either case, you will produce more and have to lower your price, as existing demand doesn't exist.

Efficiencies don't happen in a vaccum - they require both capital and it needs to be the most efficient way to produce something. In nearly all cases, if the efficiency hasn't manifested itself at full capacity, it won't manifest when under-utilised.
I don't know; desperation is a strong motivator. A lot of times, people will see something good enough, and cease to look for better. Couldn't a deflationary period have people scramble for more extreme mesures--including creating a much cheaper but perhaps much lower quality means of production. In the example given in my last post, if lower quality in additon dropped the sale prices at a rate of 20% instead, then I'll have ~\$178K still better than before.

Perhaps you are familiar with Clayton Christiansen's Innovator's Dilema and Innovator's Solution, and the notion of disruptive technologies.

Is it possible that disruptive technologies are produced more in deflationary periods because the incrental improvements don't make as much sense?

Originally Posted by ptgatsby
To eat, we could employ 3% of the population, roughly, plus probably 10-15% in support, for a long period of time. What would happen is that the 80% unemployed would have no money to buy the food, leaving the 3% unpaid - they can consume the food, but since nothing else is being produced, the money has no value to them.

That's the impossible extreme example of the issue - the system is about how resources get distributed, and the bottom line is that people only trade when profitable. People with no money and no work don't get anything, including food. And it is entirely possible that people simply cannot find work, because no one will pay. The farming example is exactly that - it is a return to the agricultural age. As each person is unable to find work, they "grow" their own food - excess labor defeats the purpose of machinery, since it makes no sense to have the machinery infrastructure if ~80% of the population can't use it, and need to farm to stay alive. (The "80%" more or less means huge economic contraction over years and years, literally returning to pre-industrial times.)

The economy has no safety net. It's more likely that economic shocks would lead this, but an interactive effect can cause people to literally be unable to pay rent or buy food at the market price. It's unlikely, because in general people will work any amount of hours to get food, but... it's not unheard of. Hard to believe because we are very advanced, and I would say that the probability is so low as to not be worth considering... but the market does not take into account "need to eat". Pricing mechanisms are not friendly to needs.

(None of this should be taken as a scenario, it's ridiculous. Aggregate demand should restore itself long long before anything like this could happen. And it would require a serious social breakdown too. But... the great depression itself wasn't that far off - not to the food point, although it does illustrate how people simply couldn't find work and were unable to afford food.)
I was just using food and energy as examples. I would think there are a lot more things, not even related to survival that would have inelastice demand. It's funny, even during the great depression, we had prodiced the Golden Age of Hollywood.

Since I was a small kid, I've actually imagined scenarios similar to the one you described but in a more utopian sense. One idea I had was to package seedlings and hydroponics equipment to sell/give to each household such that the food produced from this "Home hydropnics bay" would be enough to sustain a family of 5 indefinitely, and that enough localized power sources (a breakthru in solar perhaps) would allow the household to be self-sustaining.

An even more extreme notion is the Star Trek idea of the "Synthesizer" that will allow anyone to create whatever they want assuming they have the design of the trget object and the energy needed to be converted to mass (plus whatever extra is needed).

Another reason that prompted me posting this thread, was that I have this ideal of technology eventually freeing man-kind from ever having to work to survive. (Certainly people can work if they want.) But it seemed the natural result is deflation, which so many characterize as negative, and I am trying to issolate what features of the deflation would be negative.

Originally Posted by ptgatsby
Good question - I'd need an economist to tell me what they think. That way I can be skeptical over that too

(All jokes aside, the problem here is financial, I think. The destruction of loans, due to the monetary system, is deflationary because of the reserve system. Each loan that is taken off the books at a bank contracts the money supply, leading to both bank failure and monetary contraction. So, more of an interactive effect than any one thing in particular.)
Somehow, I think understanding what ends deflation is crucial to fully understanding deflation. I'll be searching for the answer to this as well.

Originally Posted by ptgatsby
All that is required for good deflation is an economy with contraints, notably labor constraints. High utilisation = high income = high demand... and so it is a hot economy. Deflation simply works against that - your scenario below highlights that it is possible. But everything is at the margin, and there is simply less of it (often to the point of recessions) during deflation.

Innovation, itself, happens no matter what the overall economic conditions are - it just happens much slower, as does investment, in deflationary periods. When it doesn't happen much at all is during an economic contraction. So, if you get into defaltion -> lower investment/etc -> less income -> less demand -> contraction, then things start going bad.
Deflation does seem to work against incremental innovation--I've corrected my mental model to adjust for that. But it seems like the "big ones" are still favorable. In fact, this seems to create a focus on the more disruptive innovations since they are not "crowded out" by the incremental ones.

There some theories that purport clustering of innovation during depressions, including R.W. Coombs' "institutional change" theory and A. Klienknecht's theory that during boom periods still profitable incremental improvements croud out more radical changes while in depressions more radical projects are entertained.

DSpace at VU: New evidence on the shift toward process innovation during the long wave upswing

Originally Posted by ptgatsby
I'm still researching this period. My impression is that the answer to this is not as simple as "the industrial revolution" - there were monetary issues left over from the war, and government policies on the monetary side. In addition, this period was not smooth - there were recessionary periods. So, huge amounts of government spending, specie acts, recessions/expansions in rapid succession... In my non-professional opinion, it wouldn't fall outside of the aggregate demand theories at all.

However, there is no question that the advances made here caused 'good' deflation. But there still seems to be a battle between them. The improvements caused a lot of over-capacity utilisation, which drove everything forward...
I suppose the "General Glut" thing is relevant here. But I don't believe I understand this.

Originally Posted by ptgatsby
That's fine. Rerun the scenario at a marginal improvement of 5x, 2x, 1.5x... and then rerun the same simulations with inflation It's possible to come up with scenarios that work, but it is very very rare that the gains are that significant - it tends to be progressive, with starts and leaps as the technology builds up to something that would be a net benefit.

But also keep in mind that while you model, people do not readily accept pay cuts... and that while it can work for you, if you and everyone else lay off people in sufficient quantity, you are also laying off people who buy your widgets. In an economy, ideally, those people would find work - but in situations where there is no demand for them (not systemic to deflation in general, but is indirectly related) you would sell progressively less. That means that labor might drop much faster than 2%, but if it does, it also means you can charge less (this makes your capital investment relatively more expensive, and new capital investment less likely.)
I actually did make the sale price drop by 8% in the example while keeping the production costs drop only by 2% still. I don't know if you meant some other adjustment

Originally Posted by ptgatsby
I don't disagree that it can be possible, only that systemic deflation is less ideal for capital investment. And in a deflation/contraction mix, there are huge dangers across the board. Money hording is the normal way of life, and investment goes to nearly nil. In an inflationary environment, it's "find something that will gain you money", even in a bad economy, but in a deflationary environment, it's "don't do anything to lose money" since you are already gaining while safe.
There are distinctly different types of innovations, product vs. process innovation, capacity vs. through-put, etc. I suppose the basic point of this post is that it's possible the more "game-changeing," disruptive, process, through-put type innovations get focus during deflations.

8. Originally Posted by ygolo
It is not a stellar growth in Real GDP, but real GDP grew 1.3% per annum while prices changed -1.0% percent per annum. The following source claims it is not a depression.
I think it is always important to keep in mind the broken window. Deflation does not mean that the economy, as a whole shrunk. This is important because things can and do keep chugging along no matter what happens.

The problem with using deflation is that it is both a cause and symptom. It can't be listed as "good or bad" in the same sense as a recession or boom. Even economists have a hard time with all of this - since they use money to measure the economy, if money shrinks, the economy shrinks. In reality, I don't think this is the case (I use an analogy below).

Let me work through this - maybe you can point out where I'm wrong in my thinking (with my exam this sunday, I might as well )

Deflation, no matter what the source of it, reduces employment and harms capital investment. There are no exceptions to this. The dynamics of innovation and so forth may change, I won't dispute that, but the tangible effect is reduced capital expenditures and reduced employment.

The reduced employment is the part that is most important to consider. Employment - I'll call it income to keep myself straight here - comes from producing goods, and the production of goods depends on income. That is, income and production are one and the same. This aggregate income can be called GDP, in theory - the bottom line of all good and services that are produced and consumed.

The GDP is the full pie of the economy. Without denominating it in anything, if it take less labor to produce a good, it means that the cost, as a fraction of all available labor, has gone down. This, in the purest sense, means that we all get more. This is a positive thing, of course, and is what we are striving for.

In essence, the economy is growing every single time that we make an advancement like this - if we think of it like a cylinder, the amount of production per unit of labor would correspond to height. The diameter of the pie would be akin to the rate of employment. The more people that are working, the more is produced (at the existing rate of efficiency). In a similar analogy, the economy, relative to the past and future, could be expressed as the volume. It doesn't really matter if every single person was working in an agricultural age, the efficiency level was too low to make much of an economy. Likewise, if we were to cut back our labor now, even with higher efficiency, we would be shrinking the economy. We call that a contraction now.

When we talk about deflation, we are talking about the effect long term deflation has on the economy as a whole. One source of deflation is the "lengthening" of the cylinder. However, the trade off is that the diameter shrinks - not because there is a direct relationship, but because it sends a signal into the market that there is too much labor. Labor will need to be re-absorbed, but that requires a signal that there is demand - but demand shrunk (too much labor = lower income = lower production). Monetary deflation signals the economy to slow down, essentially, and it tends to shrink capital investment (a reduction in production) and reduce the labor force (but not always the unemployment rate). In a similar way, inflation (a pull on the demand - essentially to produce more) will increase capital spending and draw people into the labor market.

Of course, as far as signals go, there is always a return to equilibrium. That is, the natural rate of unemployment and such will not be directly affected by these kinds of policies, but the market tends to be signal-blind, as we can see with the tech-boom era. If the signal exists, it reacts... a few notable exceptions, like interest rates, but... in general, you have to respond to signals because we can't differentiate between sources.

I'd like to trace the various models to their basic assumptions, because there seems to be plausible sounding arguments with data to back that go both ways.
That's my interpretation (part my view on it - I have found that economists are really lousy at explaining the macro view of increases in production. Re-indexing GDP is a pathetic way of expressing things, bleh.)

Is it possible that disruptive technologies are produced more in deflationary periods because the incrental improvements don't make as much sense?
How do you define disruptive?

I define disruptive, in the context of this conversation, as "selective bias terminology for large enough advances to be viable".

The question, however, is if a lot of small incremental changes gets in the way of large incremental changes (since capital is limited). IMO, it does not, but this is an instictive answer based on the concept that in a competitive and constrained business, each business must take on all advances that are positive sum to production. Eliminating the small ones across the board just means they wait for big ones (ie: if their competitors can't do it either, then no adoptation is required.)

Since I was a small kid, I've actually imagined scenarios similar to the one you described but in a more utopian sense. One idea I had was to package seedlings and hydroponics equipment to sell/give to each household such that the food produced from this "Home hydropnics bay" would be enough to sustain a family of 5 indefinitely, and that enough localized power sources (a breakthru in solar perhaps) would allow the household to be self-sustaining.
Well... I don't want to get into your ideas too much here, as interesting as they are. But I have to point out that you'd have about 25% efficiency for "sun on land" energy, meaning that I don't think you'll ever take solar power and use it to grow crops You might as well use direct sunlight!

Anyway, this can be used to demonstrate the adoptation. Lets say that a family can go out and buy food already. In order for them to adopt farming, they need to calculate all of the costs, including opportunity costs. In general, the full blow up costs can be viewed as a perpetuity of payments equal to the cost of buying food. Right now, including labor, it definitely doesn't make sense to grow your own food. The price of land, the cost of time... not worth it.

(I think I covered most of the rest of your post above... I'm going to read those links yet, so I won't address them now.)

9. Originally Posted by ptgatsby
Monetary deflation signals the economy to slow down, essentially, and it tends to shrink capital investment (a reduction in production) and reduce the labor force (but not always the unemployment rate). In a similar way, inflation (a pull on the demand - essentially to produce more) will increase capital spending and draw people into the labor market.
Inflation allows a higher level of inefficiency while deflation has the opposite effect. Companies that survive a period of deflation are better for it.

10. Originally Posted by Lateralus
Inflation allows a higher level of inefficiency while deflation has the opposite effect. Companies that survive a period of deflation are better for it.
Only for those who produce. Parasitic service industries just follow the curve up and down, either way (and don't I know it!)

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