Why does my economics professor say deflation is a bad thing?

As far as I can tell, his argument centered around that if prices did not rise (due to inflation), but instead fell (due to deflation), than employers would need to cut wages.  This would cause mass unemployment, as workers would be fired.  Another argument he had was that there was mass deflation during The Great Depression, which caused the economic problems.  He argued that if there was the right level of inflation, that would be good for the economy.  Wait... wait... wait..., doesn't inflation of the currency cause economic problems?

If prices face a general decrease, what are the possible reasons?  Conversely, what are the possible reasons for increasing prices?  I think it is supply and demand of the money, but I could be wrong.  And, what is the most accurate measure of inflation and deflation?  (I need this for clarification.)

Other than that, I am having a great experience with my economics professor, who seems to lean towards a free market. 

Wait, does he not see the obvious problem? Real wages = nominal wages/price. If nominal wages fall alongside prices, real wages remain unchanged. Why should this cause unemployment? He sounds like a monetarist. As for the GD, IIRC Rothbard showed it was followed by inflationary, not deflationary, policies.

Prices can rise/fall due to either real or monetary factors. In the latter case it is due to the in/deflation. In the former, it is attributable to increases in productivity in the case of falls in price.

-Jon

eliotn:

As far as I can tell, his argument centered around that if prices did not rise (due to inflation), but instead fell (due to deflation), than employers would need to cut wages.  This would cause mass unemployment, as workers would be fired.  Another argument he had was that there was mass deflation during The Great Depression, which caused the economic problems.  He argued that if there was the right level of inflation, that would be good for the economy.  Wait... wait... wait..., doesn't inflation of the currency cause economic problems?

If prices face a general decrease, what are the possible reasons?  Conversely, what are the possible reasons for increasing prices?  I think it is supply and demand of the money, but I could be wrong.  And, what is the most accurate measure of inflation and deflation?  (I need this for clarification.)

Other than that, I am having a great experience with my economics professor, who seems to lean towards a free market. 

If there is a decrease in prices then it would be assumed, all things remaining equal, there would be an increase in demand for certain goods and an increasing margin for producers. Why does your economics professor reject this fundamental economic principle and leap around it with a historical example knowing that all history is debatable at best?

eliotn:

Other than that, I am having a great experience with my economics professor, who seems to lean towards a free market. 

I lean towards the theory of gravity.  Sometimes it works, but we need the government to intervene when people start floating away.

Niccolò:

Why does your economics professor reject this fundamental economic principle and leap around it with a historical example knowing that all history is debatable at best?

Because he was taught that story when he was in school and is unable/uninterested in understanding it.

I think your professor and a lot of people are a bit naive when it comes to deflation. Deflation is not just falling prices of consumer goods. While inflation is the expansion of credit and the money supply, deflation is the exact opposite. It is the shrinking or even the collapse of it. This collapse is the result of credit infused asset bubbles that are popping. What's going on in real estate may be a good example of that. This can be a domino effect that eventually leads to falling consumer prices. Deflation and severe recession or depression almost always go together. If the bubbles are too big, government cannot inflate their way out of it. George Reisman has an excellent article published last March about that.

eliotn:

Why does my economics professor say deflation is a bad thing?

Inflation is good because the people who print the new money and spend it get to steal from everyone else.  Typically, these people financial industry insiders.

When you get to print the money, it's very easy to buy out all the newspapers, TV stations, and universities, guaranteeing that your abuses are never exposed.

With fiat debt-based money, having a stable money supply is practically impossible.  This is the whole point of the Compound Interest Paradox.

Sound money (gold/silver) is discredited, because that prevents people from having their savings stolen by inflation.  The gold standard failed due to the Federal Reserve.  The Federal Reserve printed more Federal Reserve Notes than there was physical gold, guaranteeing an eventual default.

I consider the best measure of inflation to be M2, M3 (which the Federal Reserve no longer publishes), and the price of gold.  This post illustrates a properly-adjusted real GDP calculation.

University economics professors receive their funding from the State.  If an economics professor wrote intelligently about economics, then he would not get any research grants.

I think its failry obvious that a deflating monetary supply would encourage people to save far more than the optimal amount.  If all I had to do to get rich was pile money under my bed, then there would be far less liquidity out in the markets investing and changing hands.  Whether or not this is a bad thing is debateable...  But for the government, they can only tax you on what you spend, so it's in their best intrest for money to not be stagnant.

As it usually goes, the argument against having hard currency is that overall productivity and wealth grows faster than the rate at which we find precious metals.  So any metal based currency would inherantly have deflation at some point.

Personally I think it's possible to have a non metal based currency with low inflation (just spend what you collect in taxes).  Japan and Germany have been pushing policies like this for years, and while not posting particullarly impressive growth they have very stable and technologicaly advanced industries.

NateS:

I think its failry obvious that a deflating monetary supply would encourage people to save far more than the optimal amount.  If all I had to do to get rich was pile money under my bed, then there would be far less liquidity out in the markets investing and changing hands.  Whether or not this is a bad thing is debateable...  But for the government, they can only tax you on what you spend, so it's in their best intrest for money to not be stagnant.

Optimal amount huh? So, what would that be?

NateS:

As it usually goes, the argument against having hard currency is that overall productivity and wealth grows faster than the rate at which we find precious metals.  So any metal based currency would inherantly have deflation at some point.

Yeah, and?

You don't think that prices would adjust as would interest rates?

NateS:

Personally I think it's possible to have a non metal based currency with low inflation (just spend what you collect in taxes).  Japan and Germany have been pushing policies like this for years, and while not posting particullarly impressive growth they have very stable and technologicaly advanced industries.

Yeah, don't they all...

Isn't that the Keynesian party line to get a fiat currency through the door before making everyone swallow the kool-aid?

Optimal amount?  The amount of trade that happens in a society with no currency.  Where barter, my good for your good, is the means of trade, not artificial epectations of the value of a hunk of metal out of the ground.  But currency makes trades easier and more fluid, at least that was the Kool Aid they use to get us to accept it, right?  Nevermind the fact that we can turn any element into gold, grow diamonds in relatively cheap processes, I'll just go along with the idea that this silly piece of material is worth a finite non-changing amount.

Of course prices would adjust.  Downward.  As I said, and people would be encouraged to hoard money, which itself has a wealth associated with it far higher than is actual usefulness.  Pennies and Nickels are worth less than their value as metal.  Still a Fiat currency?  As I said, the usefulness of people hoarding trinkets is debatable and ever-changing.  We can agree that inflation is bad, but tying our wealth to one material rather than real life goods is somewhat insane.

It took a hyperinflation economy and a world war for Japan and Germany to figure out the Keynesian policies lead to dumb population, populist leaders, and ultimatley failed states.  My 1.8% Japanese Bond returned 17% in dollars.  Goerge Bush, the idiot, is our president, and we are fighting an unwinnable war on the opposite side of the earth.  I don't think America has much time left on top, but hopefully the fall will teach people a lesson as it has done in other places.

Using gold or silver or metals as money is a form of barter.  The metal coin has value due to its chemical properties.  You may melt it down and use it to build other things.  Gold and silver were chosen as money because they're the least-common-denominator for barter.  If instead, you have tobacco as your monetary unit, then you have a problem because not all tobacco has equal quality.  Metal coins are fungible; they're all equivalent if you value them by weight and purity.

There's nothing immoral about hoarding gold or silver.  People do this defensively when they expect the government to default on its money, as occurred in 1933.  In a true free market, hoarding gold or silver is pointless.  You're better off investing in productive businesses and earning a return.

Also in a true free market, there's no advantage to cornering the supply of gold.  If you corner gold, then people will just use something else as money.  As you attempt to establish your corner, gold prices will skyrocket.

The bottom line is that people should be free to use whatever they want as money.  In the present, government violence forces peopel to use Federal Reserve Notes as money.  Alternate forms of money are outlawed or heavily regulated.

Once you give government the power to control money, you're on the path towards slavery.

NateS:

Optimal amount?  The amount of trade that happens in a society with no currency...  But currency makes trades easier and more fluid, at least that was the Kool Aid they use to get us to accept it, right?

Well, trade is actually increased under a currency because it solves the double coincidence of wants problem.

And the question was what is the optimal savings amount not the optimal trade amount.

NateS:

Pennies and Nickels are worth less than their value as metal.  Still a Fiat currency?

Wait, are you suggesting that this is an example of deflation?

NateS:

It took a hyperinflation economy and a world war for Japan and Germany to figure out the Keynesian policies lead to dumb population, populist leaders, and ultimatley failed states.  My 1.8% Japanese Bond returned 17% in dollars.  Goerge Bush, the idiot, is our president, and we are fighting an unwinnable war on the opposite side of the earth.  I don't think America has much time left on top, but hopefully the fall will teach people a lesson as it has done in other places.

Not really sure what this has to do with anything under discussion.

eliotn:

If prices face a general decrease, what are the possible reasons?

Either deflation of the currency, such as in Iraq when we destroyed theirs causing the value of Iraqi money to skyrocket, or production improvements that cause the cost of creating goods to fall.

eliotn:

Conversely, what are the possible reasons for increasing prices?

There is really only one reason for all prices to generally increase, and that is monetary inflation.  Since production processes will improve over time the natural progression would be for everything to get cheaper, minus huge disasters.  The costs of individual goods might go up with demand, but the overall general prices should tend to decline.

"And, what is the most accurate measure of inflation and deflation?"

Depends on your definition of inflation and deflation here.  Inflation is the increase in the money supply, not in prices, so the easiest way to measure inflation is to count how much new money was created.  This is very easy should they choose to do it.  If you mean the best way to measure price inflation, take the cost of general commodities one year and compare them to the next.  This could also be done fairly easily, but the Fed manipulates this data as much as they can to keep the cpi low.  Hedonic adjustments are made and whole sections of goods are left out (such as food and health care) because they "vary too much". 

eliotn:

He argued that if there was the right level of inflation, that would be good for the economy.

For some reason people have it in their heads that the economy cannot expand if the money supply doesn't expand with it.  I don't know where this comes from and I can't find any logic to it, but it's very common.

NateS:

Pennies and Nickels are worth less than their value as metal.  Still a Fiat currency?

LOL, yes, just a crappy fiat currency.  That's why they have laws limiting how much change you can take out of the country and are currently looking at taking the metal contents of the coins down further, and maybe get completely rid of the penny.

You don't need to have a fiat currency to inflate it either, it just makes it harder to do.  Ask any caesar.

If all I had to do to get rich was pile money under my bed, then there would be far less liquidity out in the markets investing and changing hands.

If money is removed from the economy, what happens to prices? They fall. What happens when prices fall?

We can agree that inflation is bad, but tying our wealth to one material rather than real life goods is somewhat insane.

Nope, not if the "material" possesses all the traits that make it valuable as a currency...

-Jon

Because your economics professor doesn't know "deflation" from a hole in the wall.

Inflation is always a monetary phenomenon.  Deflation is not equivalent to severe monetary contraction (i.e., the great depression).  For about (at least) 100 years prior to the installation of the Fed, prices were generally deflationary, on the order of a few % per year.  Prices fell because of competition, technology, automation, innovations, etc.  All of these are good for us.