Although I confess that this isn’t exactly on-trend in the news right now, I’m trying to understand deflation after reading an old post on on the disadvantages of Gold Currency:
>The reason it’s actually bad is because the government can’t mess with the money supply. The supply becomes tied to some shiny metal. Now, if you have a society with 100 people, and 1,000 dollars (each person having 10 dollars), then this is fine. **But in 20 years, those people will have children that will grow up and be part of the economy. But there’s still 1,000 dollars, only for 150 people now. That means each dollar is worth more, which is called deflation.**
***Source –*** u/yellowjacketcoder
The post is now 9 years old, so I thought to make a post on it here as I’m confused on the sentence in bold.
I’m not understanding the point with regards to when 150 people now exist, the same 1,000 dollars are worth more now. I understand that after 20 years, this hypothetical population goes up by 50 to 150. My intuition led me to believe that due to supply-demand economics, the same 1,000 dollars (linked to a fixed exchange rate for X ounces of gold) would be needed by more people so it would be worth more (given the supply of gold is fixed).
However, what didn’t make sense to me is how this would then be linked to the idea of deflation where spending goes down as consumers would think that prices are about to fall further (which they would, in a deflatory economy) etc.
How are the two ideas (the increased demand for the same fixed supply of dollars and the falling prices) linked, if by any means they are? Appreciate any answers as always, community (and sorry if it seems so obvious to anyone – I’ve been struggling to wrap my head around it for years)!
In: 4
Well, let’s look at this in two pieces and start with the second one.
People have different behaviors in inflation and deflation. During inflation, you know the money will be worth less later, so you buy that water heater now when it costs $500 rather than in a year with it costs you $600. In deflation the opposite happens, you put off buying things because it will cost less later. So if the water heater can keep running, you don’t replace it because what costs $500 now will be $450 in a year. If people expect deflation, it is rational to put off purchases as much as possible to take advantage of the cheaper prices in the future. Thus a lot of economic activity gets postponed and the economy contracts.
So now lets look at the first piece. If there are 1000 water heaters and $10000 dollars then each water heater would cost $10. But our supply of gold dollars is fixed (or grow much slower than population growth) and our supply of water heaters has gone up. There are now 1500 water heaters, so each one costs $6.66. So we got the deflation and once that expectation kicks in for the general populace, we get the situation talked about in the previous paragraph.
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