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
Ok, you understand how a fixed supply of money tends to cause deflation, which is a great start. An expanding economy without an expanding money supply means falling prices.
Now, just to be clear, the *cause* of deflation doesn’t really matter here. It could be a fixed money supply and expanding economy, it could be a shrinking money supply, it could be a rapid fall in the costs of production (eg. a crash in energy prices), a fall in the velocity of circulation of money, or whatever.
So let’s say prices are falling by 5% a month (unrealistic, but gets the point across). I’ve saved up $1,000 and am thinking of buying a car. I could buy it now for $1,000. Or I could hold on to my money and wait until next month, when it will cost $950.
I might need that car now and not have a choice – but the longer I wait the cheaper it’ll be. You may have experienced this yourself when buying a phone, a games console, computer parts or some other item that tends to fall in price fairly quickly. Yes, you want it now, but the longer you wait the cheaper it’ll be…
Just to make things worse, if I’m holding those dollars in cash (or the equivalent), they’re not in circulation in the economy. I’ve effectively made the supply of dollars *even smaller*. This is the velocity of circulation – how fast money is being spent and moving around the economy, and the faster it is, the higher the rate of inflation.
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