Eli5: Why is deflation more difficult to fix than inflation?
In: Economics
Deflation has a positive feedback loop built in. You earn money/value by not spending money, so more people don’t spend money which causes more deflation, basically grinding the economy to a halt.
Deflation enters a death spiral because (some) people are increasing their buying power specifically by withholding their money.
If you knew cars and houses and televisions will be 40% more expensive next June, you’d race out to buy one now.
If you knew cars and houses and televisions will be 40% *less* expensive next June, you’d squat on that money for a year.
Economic activity plummets during deflationary periods because people withhold all but the most vital non-discretionary spending so they can get it cheaper later.
That freeze tanks the markets and makes things even cheaper as companies get increasingly desperate to shed inventories, and the cycle feeds upon itself until companies finally go out of business and a supply crash forces prices up.
In true Eli5, it is easer to get people to stop spending than it is to get them to start spending. Obviusly it is an oversimplification but substitute people for institutions and you get the basic pricnicpal.
This is an interesting question!
The main problem with deflation isn’t that it’s generally harder to fix, it’s that *it’s the bad thing you were trying to avoid*.
When deflation happens that means that the prices of things need to drop. People *hate* it when you cut their wages though, even if other things are cheaper. So businesses instead rely on layoffs. All at once. Unemployment spikes and the business is in more trouble because they are still overpaying for the employees they kept!
The economy suffers because lots of people that used to be doing useful work are now unemployed.
Fiscal stimulus seems to be key to fixing it, but when the economy is bad people usually feel the government should *save* money because that feels more conservative and the bad economic situation makes them want to vote for safety (see after the great recession).
Monetary policy is more limited when fighting deflation than inflation because you lower interest rates to fight deflation, and raise them to fight inflation.
You can raise interest rates to any number you like, but it is very, very hard to take interest rates below zero percent.
Tl;Dr — Once deflation occurs the badness has *already happened*. Monetary policy is weak vs deflation. Fiscal policy is constrained by politics.
The problem is that supply is more difficult to create than demand. And deflation typically takes supply out of the market.
For someone to establish a company (ie add to supply) that usually take capital, expertise and time. Typically the investment is made when there is a forecast for enough sales over a fairly long period (many years if not decades). No one invests millions in capacity if they think it will only be profitable for one year.
Deflation means prices fall and this means suppliers go bankrupt or stop investing or downsize. This leads to loss of demand (fewer working people) and this means even more deflation as demand falls. So deflation very quickly reinforces itself into a downward spiral.
Inflation is demand exceeding supply. Prices rising incentivizes investment in more production. This means more spending (hiring etc) which then leads to growth and possibly more demand and rising inflation. While this is also an upwards spiral – what happens is usually people earn more and consume more. This is generally considered a good thing. This is why high growth economies also typically come with higher inflation.
Demand, though, is more easily tamed – increasing interest rates leading to less borrowing. In a relatively wealthy and functioning economy, eating out one day less a month, or delaying that new car purchase does not typically lead to a lot of hardship. However poor economies with poor economic governance can slip into a spiral of inflation if too much money is released into the economy such that the currency is devalued faster than economic investment is made to increase supply.
The biggest thing is that central banks mostly control inflation by manipulating interest rates. If inflation is high you raise interest rates and it comes back down, if it’s too low you lower interest rates and it goes up.
You can always make interest rates higher so you can (almost) always tame inflation. However, with deflation you can’t really go (much) below 0% interest so if you get into a situation where interest rates are at 0% and you still have deflation there isn’t much you can do in the realm of normal monetary policy.
What? Ohhohoho, no sir, it is SUPER easy to fix. Just print more or otherwise make people lose faith in the value of your currency. No, deflation is super easy to fix.
But it’s a bad thing to have in general because people will hoard cash rather than investments.
We want people to use their money, not sit on it.
Deflation is trivial to fix, just print some money and throw it around. Unfortunately, if a country is willing to do that, they are not going to have a deflation problem to begin with.
Deflation is not really a modern problem, deflation crisises date back to when gold standard was a thing and countries had a self imposed limit of not printing more money. Well.. maybe not so self-imposed, back then they couldn’t have a serious currency to begin with unless they promised convertibility to gold. Anyway, the problem that made likes of Great Depression so bad is not a thing anymore.
Because with inflation there is a point where people can’t afford to buy things so they have to stop buying which means that demand for things drops which means prices have to stop rising and wait for wages to catch up or have to drop so people will start buying again.
But with deflation, all you have to do to get “rich” is to not spend money because every day you don’t spend it, it’s worth more and you can buy more stuff tomorrow, but the same is true again tomorrow and the next day and the next day, so if you can hold off buying that car or iPhone for months or a year it’ll be a lot cheaper, so people do hold off which means prices fall more to try to tempt people to spend money which makes people think they should wait longer so things get even cheaper etc etc etc
Hey I can buy 1 icecream with my dollar today. But tomorrow I can buy 2 icecreams for a dollar. I’ll wait a month and then I can just buy the Icecream company with my dollar. Oh wait, they went bankrupt and everybody lost their jobs because nobody bought anything
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