Seems like they always want a low level of inflation but never none at all.
(And of course deflation is bad because it makes borrowing impossible, although I forget why that’s bad.)
There’s a lot of talk about inflation and deflation in this thread.
Short answer, most orthodox economists recommend a low but non-zero level of inflation. It represents favorable economic activity.
Putting it simply, no inflation at all means the economy isn’t expanding, but stagnant.
Credit is the mechanism that fuels economic growth. One of the offshoots of credit is an increase in the supply of money, i. e., inflation. If there’s no inflation, it means no one is growing.
Deflation is even worse. As noted, it makes borrowing impossible, because the banks will effectively lose money on every loan.
How would banks lose money on every loan?
Let’a say that my bank loans me $100,000 at 0% interest, to be paid back at $10,000 a year over the next ten years. The payments I’m making to the bank over the years are worth more than the money the bank originally gave to me, so they’re making a profit even at 0% interest.
If we’re talking about a scenario where the expected inflation rate is negative, then nobody would want to borrow money at 0% interest, but that is easily solved with negative interest rates.
Never underestimate the flexibility of capitalism. 
Real economic growth and price inflation are two different things, and it’s possible to have either without the other. In modern times, because of the way fiat currencies are managed, it’s true that very low inflation or deflation often correlates with low or negative economic growth. The relationship, however, is not necessary or universal–during much of the Nineteenth Century, the US experienced economic growth and deflation at the same time.
Not true at all. Lenders love deflation. Borrowers hate it. This is why William Jennings Bryan accused Wall Street of crucifying the common man “on a cross of gold” by supporting the gold-standard-driven deflation of the 1890’s.
Removed; after consideration, this is too tricky of a subject for me to make an enlightened comment.
As for the OP, one reason why economists tend not to favor an exact-zero target for inflation is that inflation measures are over-stated because they don’t take into account quality improvements.
For example, if you wanted to measure auto price inflation over (say) five years, you’d compare the price of an auto today with the price of an identical auto from five years ago. But, there was no identical auto five years ago. There are new features and quality and safety improvements that didn’t exist five years ago. The closest-equivalent auto may cost 15% more today, but it’s 10% price inflation and 5% “more and better” car. The “more and better” can’t be quantified, so it gets reported as 15% inflation. It’s a small thing, but enough to make a 0% target inappropriate.
NO! They will still charge 24% on credit balances because they are banks. Loans have nothing to do with inflation. Even adjustable rate mortgages are always 5-10% above prime rate.
I don’t know, but I am willing to bet that most of a bank’s portfolio is not consumer loans.
Rob
In the other thread we demonstrated that the 19th century was a period of net inflation, not net deflation. Moreover, while there were periods of both economic growth and deflation, it’s harder to see a neat correlation. Instead, as the second graph on this page shows, the century was a period of highs and lows, with classic booms and busts as the economy heated up and then went into “panics.”
Never Say Dice, there are many different types of banks, although some banking corporations house many of them under a single roof. Credit card loans and mortgages are not usually what people talk about when referring to banks and loans. They’re talking about the loans that banks make to corporations and big investors, the ones that are normally pegged a point or two above the prime rate. The Fed currently has its effective rate for banks down to 0%. It is practically begging people to borrow money just to keep the economy running. But that’s a different world from the consumer loan market.
The US CPI was 51 in 1800 and 25 in 1900. During the Nineteenth Century there were about 45 years of (American) deflation, 35 years of near-zero price change, and 20 years of inflation, mostly during war.
That’s my point–there was relatively little correlation. kunilou seemed to be arguing that deflation and economic growth can never go together.
In modern times, to be sure, they seldom do. Central banks target low but non-zero inflation, and inflation typically falls short of that only when the economy is performing poorly. But that doesn’t answer the question of why central banks set a non-zero target.
I believe they do (or at least try to, here in the USA). Note that you can (and folks certainly do) argue that the various corrections are inaccurate in one direction or the other, but that doesn’t mean that corrections aren’t made.
As an example, this article by the BLS (warning, PDF) describes the quality adjustments the Bureau of Labor Statistics make in the price of new cars.
I doubt that makes much difference. If a company wants to expand they will gladly pay interest even if the money is not inflating. They are doing something with an expected return. Perhaps borrowing for literal seeds expecting to grow far more on the corporate farm.
Funny, it didn’t stop anyone else.
But in my opinion the challenge facing economists is how an economy can remain healthy without growing. I want little or no inflation, a stable economy, but also low unemployment. Can it happen?
You’re right; I overstated the situation by asserting that no quality adjustments were made.
Many people do still believe that the CPI overstates inflation, however–the 1995 Boskin Commission identified substitution bias, outlet substitution bias, insufficient quality change adjustment, and new product bias as possible sources of overstatement.
Of course some economists dispute this, and even argue the reverse. I believe, however, that a general belief in overstatement accounts for one reason why central banks typically target a low but nonzero inflation rate.
Of course. Health yoked to growth is just for children, not adults. Steady states can still have full employment, 100% who want a job get a job by the state and they consume everything they produce. Basically, we consume all we produce now, except what we declare waste and reserves, so the problem is creating jobs for those who want one. Seems to me there is always public work scheduled for the future, so put them to doing it now.
The problem with deflation is that it kills economic activity. How can you make money on an investment? I buy a stock for $50/share, but in a few months, it will actually be worth less even if the company grows because each dollar is worth more. I’m bette off just sitting on my money.
Let’s say I buy $40,000 in materials to build a $60,000 house. By the time I’ve finished, my $60,000 house isn’t worth $60,000 any more. If deflation is bad enough, I’ve spent more on materials that I can get for the house. If someone does buy a house for $60,000 and then tries to sell it in five years, they won’t be able to sell it for enough money to cover their loan.
In the end, it can affect loans, though. If a bank lends money for the house, and the person walks away, seizing the house won’t pay back the principle of the loan. A collateralized obligation is no better than a non-collateralized obligation.
No, this is incorrect. You can still amass wealth by comparing value. First of, deflation doesn’t happen this rapidly, which kinda makes the numebrs unrealistic - I’m not criticizing your example, but just saying that the numbers I use will be similarly odd. In your example, you would have m ade a lot of wealth on the house, even if you have less money. That is, you spent today7’s cheap dollars to get more of tommorow’s dollars than otherwise. You may have spent $40K to get a $60K house. Instead, you’ve gotten a $45K house, but a $45K house where each dollar is worth twice as much.
Likewise, if deflation is predictable, investors can use it to see how much they should invest and how just as they with infaltion: they just build that into their required returns. Innfact, deflation can increase investment, because people will want to increase their cash for consumption later.
Ultimately, deflation doesn’t do what you claim. However, too much deflation too fast can cause money to become so valuable people can’t properly invest it - there’s just no reason to, since it can buy so much right now. But there’s nothing intrinsically bad about deflation per se - it’s just that it has foreseeable problems. Monetary specialists also probably prefer slow inflation because it’s easier to control. However, the theoretical optimum is to have exactly there right amount in circulation (that is, 1$ for each mythical 1$ value of goods and service produced at needed at any given point in time) and have that stay exactly the same with population size. The problem? Well, there’s no way to determine what that is, since a dollar value is intrinsically arbitrary.
But the inflationary policies are also heavily favored by politicians, because it;'s usually good political sense to endorse easy credit. This has consequences: the recent market meltdown was very clsoely tied to the desire of both Congress and Banks for easy credit and widespread home ownership for people who had no business getting into that position.
How could deflation ever happen in a modern economy? If it starts to happen, just print more money to “inflate” it back to the proper level, no? Or am I missing something?
But why buy a $60,000 house when the house will be worth $45K? I might as well sit on my money and still have $60K in deflated dollars. I certainly won’t be doing it for investment.
Yes, my numbers were a bit of an exaggeration, but holding capital is bad during deflationary periods. The longer I hold capital, the less it is worth. The incentive is to put my money in a coffee can and bury it in the backyard instead of building a business.
Even if my business could make money, the profits are squeezed by deflation. I might have bought materials, build something, and make a 10% profit in normal times, but during deflation, my profit will be squeezed because what I build will be worth less than it was when I originally bought my materials.
Big benefactors of deflation are pension holders because their pensions are worth more each month. They’re also the biggest losers during inflation.