Is deflation truly that bad for an economy?

[louisLavery]

Like others have said, deflation, like inflation, is neither good or bad in and of themselves.

Inflation favours those with debt while penalising savers.
Deflation penalises those with debt while favouring savers.
For every argument for/against deflation there's a symmetric argument against/for inflation. So it seems to me 0% is best as it favours neither.

@tee-rex: By this you confirm that you don't understand how deflation impacts an economy, and that you didn't read the previous few pages of this thread where I explained it mathematically why deflation simply cannot be a mirror reflection of inflation.

You're right, I didn't read all the other pages,as there are 8, I think. I've now had a quick look through them but couldn't find your mathematical explanation as to why inflation and deflation are not mirror images. I'd be interested in seeing it so would be grateful if you'd say what number it is. Thanks.

BTW, this might be of interest to you and others, http://ftalphaville.ft.com/2015/03/23/2122452/economists-agree-deflation-is-either-good-or-bad-or-irrelevant/#respond

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[tee-rex]

Like others have said, deflation, like inflation, is neither good or bad in and of themselves.

Inflation favours those with debt while penalising savers.
Deflation penalises those with debt while favouring savers.
For every argument for/against deflation there's a symmetric argument against/for inflation. So it seems to me 0% is best as it favours neither.

@tee-rex: By this you confirm that you don't understand how deflation impacts an economy, and that you didn't read the previous few pages of this thread where I explained it mathematically why deflation simply cannot be a mirror reflection of inflation.

You're right, I didn't read all the other pages,as there are 8, I think. I've now had a quick look through them but couldn't find your mathematical explanation as to why inflation and deflation are not mirror images. I'd be interested in seeing it so would be grateful if you'd say what number it is. Thanks.

BTW, this might be of interest to you and others, http://ftalphaville.ft.com/2015/03/23/2122452/economists-agree-deflation-is-either-good-or-bad-or-irrelevant/#respond

Below I cite three of my posts (emphasis added) relevant to the matter that pretty much explain this all. Note that I specifically point out that deflation is not a mirror image of inflation, since, obviously, you are not the first to come up with such an idea.

On enterprise side, although the amount of currency they earn decreased, but currency appreciated, their real income will increase, salary become cheaper, they could hire more people and drive larger projects. This also happened when bitcoin price reached $1000+, lots of projects were setup back then

In real life, producers' profits may turn negative due to decreased prices. But negative is negative, and you can't do anything about it, deflation or not. What you say is probably the most common mistake people make when they discuss deflation "on enterprise side". In short, deflation is not a mirror reflection of inflation (as many erroneously believe).

I guess many have an intuitive assumption that company profits would be decreasing in proportion to the decrease in prices of the goods the company sells (hence comes the idea that their real income will increase despite the drop in prices).

This is flat-out wrong.

There are two things to understand why the collapse in aggregate demand is bad (and very bad at that). First, it is enterprise that creates value, so it comes before anything else. Secondly, when prices are falling, it becomes more risky to run it, since you may end up with less money than if you weren't engaged in enterprise altogether.

Remember, negative remains negative, no matter what. In inflation profits in nominal terms increase, so you expect that in deflation they would decrease (thus mirroring inflation), while in reality profits not just decrease but can actually turn into losses.

[louisLavery]

@tee-rex #176:

TBH, I was hoping for a more mathematical argument than what you give in #176, I just find algebra easier to follow than words (maybe because it's less ambiguous).

Anyway, you seem to be making a point about profit. TBH, I hadn't analysed that, but having slept on it have now done so and am still of the opinion the two flations are mirror images (perhaps complements, or conjugates, is a better term. But, as I inclined above, I'm not that good with words).

===================================================
Here's how I see it.

First, if inflation is p (per week) then the corresponding deflation is q = -p/(1+p) [1].

Say a trader has production costs W and sells what is produced for R = 2W, each week (it's a little easier if we assume 100% mark up).

If now inflation kicks in at p, then on the first week W_1 = W(1+p) and R_1 = R(1+P), thus maintaining R/W = 2.
And on the kth week W_k = W(1+p)^k and R_k = R(1+p)^k, again maintaining R/W = 2.

The deflation case is trivially the same, with p replaced by q = -p/(1+p), and we find R/W = 2 as above.

That's it really.
===================================================

Also, others support my view[2]. Sorry, but I haven't had time to find a specific file, but you can scroll through some of the contents of the books in [2]. Ah, just managed to load this[3] (it was taking forever last night so I gave up), in which the 4th para starts, "Inflation's mirror image, deflation, has less of a dark historical legacy". I haven't read it all so don't know if it says much more about them being mirror images. It would be nice to find a pdf, or what ever, giving an argument for or against my assertion. If you manage to find such please let me know. Still, I do find it a useful guide, but maybe that's because symmetry has always been strong in my thinking, in fact even before I knew it was called symmetry.


[1] This is easily proved: If a period of inflation is followed/preceded by a complimentary period of deflation then the total inflation/deflation must be 0, thus we require (1+p)(1+q) = 1.

[2] https://www.google.co.uk/?gws_rd=ssl#q=deflation+is+the+mirror+image+of+inflation

[3] http://www2.hmc.edu/~evans/inflation.pdf

[tee-rex]

@tee-rex #176:

TBH, I was hoping for a more mathematical argument than what you give in #176, I just find algebra easier to follow than words (maybe because it's less ambiguous).

Anyway, you seem to be making a point about profit. TBH, I hadn't analysed that, but having slept on it have now done so and am still of the opinion the two flations are mirror images (perhaps complements, or conjugates, is a better term. But, as I inclined above, I'm not that good with words).

If I don't use formulas this doesn't in the least mean that my argument is less mathematical than would have been if I did. My point is that you don't need deep understanding of economics to see why deflation is bad, since it can be easily shown by pure mathematical reasoning.

[tee-rex]

Here's how I see it.

First, if inflation is p (per week) then the corresponding deflation is q = -p/(1+p) [1].

Say a trader has production costs W and sells what is produced for R = 2W, each week (it's a little easier if we assume 100% mark up).

If now inflation kicks in at p, then on the first week W_1 = W(1+p) and R_1 = R(1+P), thus maintaining R/W = 2.
And on the kth week W_k = W(1+p)^k and R_k = R(1+p)^k, again maintaining R/W = 2.

The deflation case is trivially the same, with p replaced by q = -p/(1+p), and we find R/W = 2 as above.

That's it really.

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

[dinofelis]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

No.  If you take into account the fact that there's a time difference between the cost of production, and the price of selling the product, you should also take into account the real interest of the blocked capital.

So if the difference in time between t1 and t2 is large enough to accumulate significant inflation or deflation, you have to take into account that the capital blocked at time t1 in the production, namely W_t1, costs you the interest on that capital between t1 and t2.  So your actual benefit is not R_t2 - W_t1 but rather R_t2 - W_t1*(1+(t2-t1)*i).

If you now correct the interest rate for the inflation (that is, i = i0 + p), you will find that inflation or deflation is totally indifferent.

[tee-rex]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

No.  If you take into account the fact that there's a time difference between the cost of production, and the price of selling the product, you should also take into account the real interest of the blocked capital.

So if the difference in time between t1 and t2 is large enough to accumulate significant inflation or deflation, you have to take into account that the capital blocked at time t1 in the production, namely W_t1, costs you the interest on that capital between t1 and t2.  So your actual benefit is not R_t2 - W_t1 but rather R_t2 - W_t1*(1+(t2-t1)*i).

If you now correct the interest rate for the inflation (that is, i = i0 + p), you will find that inflation or deflation is totally indifferent.

You cannot just correct i for inflation and not correct R_t2 for it at the same time (since you would sell at higher, already inflated prices). In fact, you can't even correct it (W_t1*(1+(t2-t1)*i)) for inflation at all (since your costs are fixed at t1). You buy raw materials at old uninflated prices, and now you suggest we should recalculate their cost at new prices when we sell finished goods (that is i = i0 + p)? That would be an entirely novel idea in accounting. Strictly speaking, you can't even write R_t2 - W_t1*(1+(t2-t1)*i), or that wouldn't be your profit (or benefit, in your speak).

Nevertheless, explain to me how this can help you if you suffer losses due to deflation? What exactly are going to correct? And what are you going to multiply the factor (R_t2 - W_t1) by if it is less than zero? Will the end result magically turn into positive?

Why should I repeat again and again that negative is negative?

[twiifm]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

No.  If you take into account the fact that there's a time difference between the cost of production, and the price of selling the product, you should also take into account the real interest of the blocked capital.

So if the difference in time between t1 and t2 is large enough to accumulate significant inflation or deflation, you have to take into account that the capital blocked at time t1 in the production, namely W_t1, costs you the interest on that capital between t1 and t2.  So your actual benefit is not R_t2 - W_t1 but rather R_t2 - W_t1*(1+(t2-t1)*i).

If you now correct the interest rate for the inflation (that is, i = i0 + p), you will find that inflation or deflation is totally indifferent.

You cannot just correct i for inflation and not correct R_t2 for it at the same time (since you would sell at higher, already inflated prices). In fact, you can't even correct it (W_t1*(1+(t2-t1)*i)) for inflation at all (since your costs are fixed at t1). You buy raw materials at old uninflated prices, and now you suggest we should recalculate their cost at new prices when we sell finished goods (that is i = i0 + p)? That would be an entirely novel idea in accounting. Strictly speaking, you can't even write R_t2 - W_t1*(1+(t2-t1)*i), or that wouldn't be your profit (or benefit, in your speak).

Nevertheless, explain to me how this can help you if you suffer losses due to deflation? What exactly are going to correct? And what are you going to multiply the factor (R_t2 - W_t1) by if it is less than zero? Will the end result magically turn into positive?

Why should I repeat again and again that negative is negative?

I agree.  What you described connects to Keynes "sticky prices" and "sticky wages".

In deflation period firms can't automatically adjust prices.  What they do is cut expenses.  Usually the first is layoffs

[louisLavery]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

I feel we are arguing past each other. That's probably my fault as, as I said, I hadn't analysed profit.  I had a sleep on it but likely should have spent another night on it, sorry about that. Let's recap my (and many others) claim that inflation and deflation are mirror images.

In my original post #170 I said,

"Inflation favours those with debt while penalising savers.
Deflation penalises those with debt while favouring savers."

I think we can agree on that, yes?

I followed that with,

"For every argument for/against deflation there's a symmetric argument against/for inflation. So it seems to me 0% is best as it favours neither."

Thus implying they are mirror images.

You came back with an argument (#176) about profit turning negative, yes?  (I then started trying to form a view about profit. That, I think, was a mistake, on my part).

The thing is, that profits can turn negative under deflation is not an argument against my conjecture, AFAICS.

Profits relate to a producer. A producer's mirror is a consumer. Those are the symmetric entities I should have identified, and be debating. So let's do that.

My claim is that if inflation favours the producer (and so disfavours the consumer) then deflation disfavours the producer (and so favours the consumer).

But it seems to me that you've already argued deflation disfavours the producer, yes? And I assume you're of the opinion inflation favours the producer, yes?

So we are in agreement on this, yes?

Of course that doesn't prove my conjecture, I know.

Anyway, I'll leave it at that for now, and wait see if you agree my points so far,

[tee-rex]

You came back with an argument (#176) about profit turning negative, yes?  (I then started trying to form a view about profit. That, I think, was a mistake, on my part).

The thing is, that profits can turn negative under deflation is not an argument against my conjecture, AFAICS.

Profits relate to a producer. A producer's mirror is a consumer. Those are the symmetric entities I should have identified, and be debating. So let's do that.

My claim is that if inflation favours the producer (and so disfavours the consumer) then deflation disfavours the producer (and so favours the consumer).

But it seems to me that you've already argued deflation disfavours the producer, yes? And I assume you're of the opinion inflation favours the producer, yes?

So we are in agreement on this, yes?

Small stable inflation favors producers (large 2-digit inflation cannot be stable by definition, let alone run-away inflation) and doesn't favor the consumer much (though it contributes to better employment overall). Deflation, on the contrary to what you say or may think, doesn't favor the consumer either, and most evident this becomes in the long run. You may think that profits and losses are not relevant to this, but here I should cite myself once again:

There are two things to understand why the collapse in aggregate demand is bad (and very bad at that). First, it is enterprise that creates value, so it comes before anything else. Secondly, when prices are falling, it becomes more risky to run it, since you may end up with less money than if you weren't engaged in enterprise altogether.

Since producers are more inclined not to reinvest their profits under deflation, thereby they have to cut production and lay off people (for reasons explained above). This directly hits on the consumer. Thus we have the consumer suffering in both cases, but deflation is more dangerous since it also hits hard on the producer. And not a trace of mirroring by any means.

And inflation doesn't favor borrowers since less lenders are willing to loan in the inflationary environment, and thus less credit overall due to higher interest rates and smaller number of lenders.

[twiifm]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

I feel we are arguing past each other. That's probably my fault as, as I said, I hadn't analysed profit.  I had a sleep on it but likely should have spent another night on it, sorry about that. Let's recap my (and many others) claim that inflation and deflation are mirror images.

In my original post #170 I said,

"Inflation favours those with debt while penalising savers.
Deflation penalises those with debt while favouring savers."

I think we can agree on that, yes?

I followed that with,

"For every argument for/against deflation there's a symmetric argument against/for inflation. So it seems to me 0% is best as it favours neither."

Thus implying they are mirror images.

You came back with an argument (#176) about profit turning negative, yes?  (I then started trying to form a view about profit. That, I think, was a mistake, on my part).

The thing is, that profits can turn negative under deflation is not an argument against my conjecture, AFAICS.

Profits relate to a producer. A producer's mirror is a consumer. Those are the symmetric entities I should have identified, and be debating. So let's do that.

My claim is that if inflation favours the producer (and so disfavours the consumer) then deflation disfavours the producer (and so favours the consumer).

But it seems to me that you've already argued deflation disfavours the producer, yes? And I assume you're of the opinion inflation favours the producer, yes?

So we are in agreement on this, yes?

Of course that doesn't prove my conjecture, I know.

Anyway, I'll leave it at that for now, and wait see if you agree my points so far,

It helps if you think of the economy of an ecosystem instead of dichotomy between producers/ consumers, borrowers/ savers, etc..

Deflation is bad for everybody.  Slight inflation advantages some and tolerable for most

[dinofelis]

You cannot just correct i for inflation and not correct R_t2 for it at the same time (since you would sell at higher, already inflated prices). In fact, you can't even correct it (W_t1*(1+(t2-t1)*i)) for inflation at all (since your costs are fixed at t1). You buy raw materials at old uninflated prices, and now you suggest we should recalculate their cost at new prices when we sell finished goods (that is i = i0 + p)? That would be an entirely novel idea in accounting. Strictly speaking, you can't even write R_t2 - W_t1*(1+(t2-t1)*i), or that wouldn't be your profit (or benefit, in your speak).

No, you're missing my point. 

At t1, if there is an inflation rate p, then interests will be i0 + p, where i0 is "purely economical and independent of inflation" (that is, the market price for "store of value", independent of the currency at hand).

Now, if you buy your stuff at time t1 for a price W_t1, you can consider that you BORROW money at t1 for an amount of W_t1.  You will pay back that loan at t2, when you get to sell your product for a price R_t2.

So during the time t2 - t1, you have a loan of magnitude W, on which you will have to pay an interest (t2 - t1) * (i0 + p) * W.

So the extra COST of inflation equals (t2 - t1) * p * W.

If you have deflation, this is a gain (p is negative).

Now, you are right that this doesn't entirely compensate the "gain" due to inflation, of the increase of R.

Indeed, you can say that R_t2 = R_t1 * (1 + (t2 - t1) * p).  So R_t2 is bigger (in nominal value) and it "brings you" indeed an extra amount of cash which is (t2 - t1) * p * R_t1.

If your sales price were exactly equal to your cost, that is R_t1 = W_t1, and you would not have created value, then the COST of inflation, W_t1 * p * (t2 - t1) would cancel out ENTIRELY the 'benefit of inflation' R_t1 * p * (t2 - t1), because it is equal.

In the same way for negative p (deflation) of course.

However, if you create value, that is, R_t1 > W_t1, then you do have a small difference: you gain somewhat if there is inflation (on your benefit) and you loose somewhat if there is deflation (on your benefit)... at least in nominal numbers.  However, as your gain in nominal numbers, can now buy LESS, that is even corrected for a second time.

But if you make a benefit, you will still make a benefit, whether there is inflation or deflation.  Because the interest on the borrowed money to do your production is corrected for it.

[dinofelis]

You assume that goods are produced and sold instantaneously, which is not the case in real life. Production cycles can be as long as a few years. If the time span of your production cycle was equal to zero, then neither inflation nor deflation would have any impact on your profits (in percentages), which is what your example reveals.

Correct usage should be R_t2/W_t1, where t2 and t1 are different time moments for revenue and cost flows in a production cycle, t2 > t1. In inflation R_t2 is always greater than W_t1 (provided we were profitable before inflation set in), whereas in deflation R_t2 may become less than W_t1 (even if we were profitable before deflation set in, i.e. R > W and R/W time-invariant). That would mean a loss. So, in inflation you can never mathematically suffer a loss due to inflation per se (if you were profitable before, of course), while in deflation it becomes quite possible through the effect of deflation as such.

No.  If you take into account the fact that there's a time difference between the cost of production, and the price of selling the product, you should also take into account the real interest of the blocked capital.

So if the difference in time between t1 and t2 is large enough to accumulate significant inflation or deflation, you have to take into account that the capital blocked at time t1 in the production, namely W_t1, costs you the interest on that capital between t1 and t2.  So your actual benefit is not R_t2 - W_t1 but rather R_t2 - W_t1*(1+(t2-t1)*i).

If you now correct the interest rate for the inflation (that is, i = i0 + p), you will find that inflation or deflation is totally indifferent.

You cannot just correct i for inflation and not correct R_t2 for it at the same time (since you would sell at higher, already inflated prices). In fact, you can't even correct it (W_t1*(1+(t2-t1)*i)) for inflation at all (since your costs are fixed at t1). You buy raw materials at old uninflated prices, and now you suggest we should recalculate their cost at new prices when we sell finished goods (that is i = i0 + p)? That would be an entirely novel idea in accounting. Strictly speaking, you can't even write R_t2 - W_t1*(1+(t2-t1)*i), or that wouldn't be your profit (or benefit, in your speak).

Nevertheless, explain to me how this can help you if you suffer losses due to deflation? What exactly are going to correct? And what are you going to multiply the factor (R_t2 - W_t1) by if it is less than zero? Will the end result magically turn into positive?

Why should I repeat again and again that negative is negative?

To illustrate the naivity of "inflation makes for easier benefit", consider the following case:

at time t1 you buy for amount W a set of goods (say, a stock of soap).

At time t2 you sell your stock of goods for price R.

You are concluding naively that as R at t2 will be higher (because of inflation) at t2 than the price you gave for it at t1, that you will have made some benefit !!

So under inflation, storing stuff is generating a benefit under this kind of reasoning !

You immediately see where that goes wrong.

You could have placed your amount of money W on a savings account with an interest i = i0 + p at time t1.

At time t2, that amount of money would have increased by a factor (t2 - t1) * p * W simply due to inflation, which is of course EXACTLY the "benefit" you would have obtained by selling your soap.

The same is of course valid in deflation.... except that if the deflation equals i0, YOU DON'T NEED A SAVINGS ACCOUNT ANY MORE.

And THIS is the true panic that mild deflation inspires: normal people don't need a savings account any more.  You don't need the financial institutions any more to compensate (partially) for the loss your money suffers under inflation.  3/4 of financial institutions are out of business under mild deflation, as they are useless.

THIS is the ONLY serious reason why politicians and financials panic for mild deflation.  As others said, mild deflation and mild inflation are mirror images of one another on all other economic aspects.

[dinofelis]

In my original post #170 I said,

"Inflation favours those with debt while penalising savers.
Deflation penalises those with debt while favouring savers."

I think we can agree on that, yes?

I would not even agree with that, as long as inflation or deflation is steady and expected, for the simple reason that interest rates are compensated for it.

Someone in debt might think that inflation is good for him.  But at an inflation rate of 2%, his nominal interest rate on his debt will be 2% higher than without that inflation.  So normally he doesn't win anything.

The only winners of inflation are those that take a benefit on money and interest FLUXES.  Those are higher with inflation.  There are two kinds of organisations that do this: financial institutions and states.

[dinofelis]

Deflation is bad for everybody.  Slight inflation advantages some and tolerable for most

I like that.  I propose that from tomorrow on, everybody on this planet pays me 0.1% of his income.  It is a rule that advantages some (in this case, me), and it is tolerable for most

[dinofelis]

I agree.  What you described connects to Keynes "sticky prices" and "sticky wages".

In deflation period firms can't automatically adjust prices.  What they do is cut expenses.  Usually the first is layoffs

Ah, the ultimate argument when it is shown that all principal effects of inflation and deflation are economically essentially neutral and mirror of each other if you take all effects into account.

Point is, stickiness of prices are only valid in the short term.  Otherwise, nobody would even be willing to pay $1.- for a loaf of bread, given that we are used to 10 cents for it !

Stickiness of prices is just as well an argument against inflation as against deflation (and in fact, implies that inflation and deflation should be MILD).  Consumers DO adapt to higher prices in inflation.  They are not holding on to any "stickiness" in the long run.  They adapt to the market: if there ain't any more at the old, lower prices, they are willing to pay higher prices.

The stickiness of prices in wages and so on only comes about because of LEGISLATION which does some kind of price fixing.  If those prices were just as free as a loaf of bread, and the labor market would be fluid, then wages would adapt just as well as the price of a loaf of bread.

If you have an inflation of 2%, you have an effective wage drop of 2% a year, and you have to negociate a wage increase to keep the same effective wage.  If you have a deflation of 2% a year, you'd get an automatic wage increase of 2% a year.  First of all, that is not so terribly uncommon.  And second, there could be wage lowering negociations from the side of the employer.  They would in times of deflation be just as natural as wage increase negociations in times of inflation.

There is no long run stickiness of prices.
Markets always impose prices.

[tee-rex]

You cannot just correct i for inflation and not correct R_t2 for it at the same time (since you would sell at higher, already inflated prices). In fact, you can't even correct it (W_t1*(1+(t2-t1)*i)) for inflation at all (since your costs are fixed at t1). You buy raw materials at old uninflated prices, and now you suggest we should recalculate their cost at new prices when we sell finished goods (that is i = i0 + p)? That would be an entirely novel idea in accounting. Strictly speaking, you can't even write R_t2 - W_t1*(1+(t2-t1)*i), or that wouldn't be your profit (or benefit, in your speak).

No, you're missing my point. 

At t1, if there is an inflation rate p, then interests will be i0 + p, where i0 is "purely economical and independent of inflation" (that is, the market price for "store of value", independent of the currency at hand).

Now, if you buy your stuff at time t1 for a price W_t1, you can consider that you BORROW money at t1 for an amount of W_t1.  You will pay back that loan at t2, when you get to sell your product for a price R_t2.

So during the time t2 - t1, you have a loan of magnitude W, on which you will have to pay an interest (t2 - t1) * (i0 + p) * W.

So the extra COST of inflation equals (t2 - t1) * p * W.

It seems that it is you who is missing my point.

First of all, if you do really borrow capital (which is a viable way of financing you working capital), the costs of it, that is interest paid, are already included in W_t1 (yet another entry in total costs). Furthermore, inflation means that the price which you sell your goods at also rises, so your extra cost of inflation will be offset in the revenue. And last but not least, you can indeed write something like R_t2 - W_t1*(1+(t2-t1)*i), but this will be not what you likely wanted to say. What is i here? If it is a rate of inflation in disguise then it will be offset by an increase in R_t2 (since prices grow), so you in fact should write something like R_t1*(1+(t2-t1)*i)) - W_t1*(1+(t2-t1)*i). But the latter shows that your nominal profit increases by the rate of inflation, and remains the same in percentages as before. So, essentially, nothing has changed for the producer. If you add p to i0 it will be as well offset in the resulting R_t2 (by definition).

But that was not my point entirely.

[tee-rex]

If you have deflation, this is a gain (p is negative).

Now, you are right that this doesn't entirely compensate the "gain" due to inflation, of the increase of R.

Indeed, you can say that R_t2 = R_t1 * (1 + (t2 - t1) * p).  So R_t2 is bigger (in nominal value) and it "brings you" indeed an extra amount of cash which is (t2 - t1) * p * R_t1.

If your sales price were exactly equal to your cost, that is R_t1 = W_t1, and you would not have created value, then the COST of inflation, W_t1 * p * (t2 - t1) would cancel out ENTIRELY the 'benefit of inflation' R_t1 * p * (t2 - t1), because it is equal.

In the same way for negative p (deflation) of course.

However, if you create value, that is, R_t1 > W_t1, then you do have a small difference: you gain somewhat if there is inflation (on your benefit) and you loose somewhat if there is deflation (on your benefit)... at least in nominal numbers.  However, as your gain in nominal numbers, can now buy LESS, that is even corrected for a second time.

You still don't see that it is not the same for deflation. In deflation you may end up with less money than you started with, i.e. R_t2 < W_t1 due to prices falling, even though, on paper you may easily get R_t2 > W_t1 * (1-(t2-t1)*i). But the latter won't make up for the losses, which will be real. If you write for deflation what you wrote for inflation, you will see the absurdity of your reasoning. Why did you not do this?

As I said before, you can indeed write something like R_t2 - W_t1*(1+(t2-t1)*i), but this won't be your profit, since it is a premium that you get or lose over another investment which gives you i%. If you get losses due to deflation, i.e. end up with less money in your pockets, will you be better off than if you hadn't invested your money at all?

[dinofelis]

It seems that it is you who is missing my point.

First of all, if you do really borrow capital (which is a viable way of financing you working capital), the costs of it, that is interest paid, are already included in W_t1 (yet another entry in total costs). Furthermore, inflation means that the price which you sell your goods at also rises, so your extra cost of inflation will be offset in the revenue. And last but not least, you can indeed write something like R_t2 - W_t1*(1+(t2-t1)*i), but this will be not what you likely wanted to say. What is i here?

The nominal interest.  Because the capital you blocked at time t1 for buying your goods at that moment, costs you an interest i.
The nominal interest is the real interest plus the inflation rate.

If it is a rate of inflation in disguise then it will be offset by an increase in R_t2 (since prices grow), so you in fact should write something like R_t1*(1+(t2-t1)*i)) - W_t1*(1+(t2-t1)*i).

p is the inflation rate, i is the nominal interest rate, which equals i0 + p.
To R, you should only apply p of course.  To W, you apply i0 as well as p.  But essentially you do the same as I do, yes: the increase in output at time t2 because R rose nominally because of inflation is compensated by the higher interest you have to pay on your loan of W because of inflation when R = W.

In other words, whether there is inflation or not, if R = W, the "higher nominal sales price" will be compensated for the higher interest rate you have to pay on your loan of W because of inflation.

[dinofelis]

You still don't see that it is not the same for deflation. In deflation you may end up with less money than you started with

No, you don't.  Well, if you do, you will ALSO loose when there is inflation.  Simply because of the higher interest you have to pay on your loan of W.

Imagine that you buy this year for $1000 of stuff, that the real interest rate is 6% and that inflation is 5%.  This means that the nominal interest rate is 11%.  You have borrowed your $1000,- at 11% interest rate.
Imagine your product is ready after a year, and it is worth 2% more in real terms as the cost.  So it would have been sold at $1020,-  this year, but because of inflation, you can ask $50 more for it next year (I'm not considering second-order effects).

So you can sell your stuff for $1070 next year.  However, you have to pay $110 of interest on your loan.  So net, you are LOOSING money: you gained $70 (20 value creation, and 50 inflation) but you have to pay $110 in interest), even though you sold for more than you bought.

---> $40 LOSS.

Now, consider 5% deflation.  The nominal interest rate is now 1% (real interest rate remains 6%).

You have borrowed $1000 at 1%.  You could again have sold your product this year at 1020, but because of deflation, you can only sell it for 50 less, that is, for $970.  That's your thing: you can actually sell it for LESS money.  Yes.  But you only have to pay $10 as an interest.

So you've lost $30 on your sales, and you've lost $10 because of the interest: $40 LOSS.


The loss actually only comes about because of the difference of the REAL INTEREST and your ADDED VALUE.
The real interest rate was 6%, and your added value was only 2%.  So you made a loss of 4% IN BOTH CASES.


Let us now consider a value creation of 15%, with the same numbers.

5% inflation: you could have sold your product this year for $1150, but because of inflation, you can sell it next year for $1200,-
You have to pay $110 interest on your loan, so your net gain is $90.

5% deflation: you could have sold your product this year for $1150, but because of deflation, you can only sell it for $1100.-
You have to pay $10 interest on your loan, so... your net gain is STILL $90.