Thursday, April 04, 2013

Wet pavements don't cause rain

Megan has a good, conventional wisdom post, on the mechanics of debt and deflation in Japan. Japan is a fantastic case study because it has run up massive, truly massive, deficits, and has had extremely loose monetary policy for almost a generation now, and still remains in the post-crash funk it was in after its property bubble popped in the mid-80s. And yet, despite all of this, priors around deficits and monetary policy remain unchanged. Here's Megan:

I join most economists in thinking that deflation is bad, and it will be good if Japan can stop it.  Deflation causes money hoarding--if that dollar you have now will be worth more later, it only makes sense to spend it later.
Deflation does not cause money hoarding any more than wet pavements cause rain. Money hoarding--driven by animal spirits--causes deflation when the Government does not meet it's responsibility as the currency monopolist to print money that people desire to hoard. When you can hoard through paying lower taxes (or getting a cheque from the Government) you do not need to try and hoard by skimping on your grocery bill, and thus reducing someone else's income.

Similarly, think through the assertions here and compare them to what actually happens in real life:
Deflation is good for creditors.  But it's terrible for debtors.  Say that business is slow and your mortgage is really starting to pinch.  If inflation is 2-3%, you just need to hold on a bit; every year, the real value of your mortgage will shrink, making it easier to pay.
Really? If your nominal income stays the same and your nominal mortgage stays the same, how will a change in the real value of anything have any impact?

Debt is nominally denominated, it's just a number in a spreadsheet somewhere, just as currency is. Nominal problems need nominal solutions, otherwise they become real problems and you get high unemployment and the various social ills that come from that.

4 Comments:

Blogger Dan Kervick said...

W., I assume that by "inflation" she doesn't just mean a relative inflation impacting only consumer prices, but a general inflation that affects all prices concurrently - including wages.

I'm not sure about the hoarding issue. It seems to make sense in theory that if there is a general and continuing fall in prices, people will experience an increased incentive to hold onto their money, since its purchasing power increases by the day.

4:32 PM  
Blogger Joshua Wojnilower said...

Dan, Wouldn't a general inflation just imply that average wages rise concurrently with all other prices? If so, it's plausible that many or most households would not experience a decline in the real burden of debt but instead would face a decline in purchasing power.

On the second point, I think you make a good case for circularity in the relationship between money hoarding and deflation.

10:26 PM  
Blogger winterspeak said...

Hi Dan:

You are right, she does, but how, exactly, does this happen? Is it through automatic COLA adjustments? What of income streams that don't have a COLA mechanism? Without COLA, how might, say, and oil shock translate to higher salaries more broadly?

Similarly, how much time flexibility does an individual really have over consumption? Can I put off eating food or having a roof over my head because because I can buy more food tomorrow, or more roof?

I think SRW is right in that a large portion of savings is essentially insurance, and consumption decisions are mostly focused around immediate intensity (do I buy a toyota or bmw?) But economics models have this fungible slope that I don't think is a good representation of the actual dynamics at play.

10:38 AM  
Blogger Dan Kervick said...

Hi winterspeak,

Yes, you are right. I think that in the old days of strong labor and COLAs wages and prices were more closely linked. But in these days, any central bank attempt to engineer a CPI hike, even if successful (which is doubtful in itself), will probably leave wages lagging behind. I just mean to point out that when McArdle and others say things like "inflation would be good for debtors:, they are using the term "inflation" in a kind of textbook economic sense in which it refers to all prices of all kinds rising by by more or less the same percentage concurrently.

How policy makers could actually engineer this amazing kind of textbook inflation is something they don't concern themselves with other than the fact that they probably learned somewhere back in Econ 101 that the central bank "controls the money supply" and so can do it. So, couple a crude quantity theory of money prices with a crude picture of central bank control over the quantity of money, and policy makes sense.

You might be right about necessities, but I think for bigger ticket items, people often do refrain from spending until they are convinced that prices in the market for that good have bottomed out.

5:08 PM  

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