Eli5: why can’t we just “deflate” money, and why is it bad?
In: 620
First off, we *can* do that, and it goes by the name “quantitative tightening.”
Okay, sounds great, inflation problem solved, we can go about our business. Yay!
But it’s much worse than you think. What quantitative tightening does is it removes liquidity from the system, which means there’s less money for banks to borrow from the federal government, which leads to it being more difficult for businesses to start up or borrow money for capital improvements, which eventually leads to economic stagnation if you let it go on long enough.
Then, when the inflation problem has hit zero and tips into deflation territory, you start thinking, “Great! My money is worth more than it was yesterday!” and then you rationalize this as, “My money will be worth more tomorrow. I will not spend my money today. Or tomorrow, because it will be worth more the next day!” and so on and so on. This is obviously problematic for businesses, because people are now hoarding their money, so the businesses (which still have to pay rent and salaries) start losing money, so they start letting people go, and now you’ve got an unemployment problem on your hands. And then, as businesses shut down, new ones don’t open in their place because your quantitative tightening policies have made it so banks aren’t loaning money to anybody except for companies that already have so much money that they don’t need it. This exact scenario happened in 2008, although it started for reasons unrelated to quantitative tightening. However, when consumer spending goes down, the first places to go are local restaurants, and it spreads like a cancer from there.
Meanwhile, amidst all of this, because consumer spending has hit near-zero levels, the stock market tanks, taking everyone’s retirement portfolios along with it, so now if you were planning to retire next year, you’re working another ten years. You’d like to sell your house in order to move into a smaller place, but nobody can get home loans, so you’re stuck where you are. Maybe people take what they can get for their houses, which drives down home values, which drives down property taxes, which now is a big problem for communities’ abilities to pay their bills for things like fire and police departments, infrastructure maintenance and construction, school funding, et cetera.
And it’s all because people started the day by saying, “I’m not going to spend money today.”
Latest Answers