Is deflation truly that bad for an economy?

[dinofelis]

You were claiming that deflation is a mirror image of inflation, right? Now you seem to be backpedaling this issue?

Not at all.  Where do you get that ?

Here is your post. It seems that I remember them better than you do:

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.

Well, that still holds, doesn't it ?

You make $20 of profit in the 3 cases.

I was asking where you thought I was back-pedalling ?

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[tee-rex]

You were claiming that deflation is a mirror image of inflation, right? Now you seem to be backpedaling this issue?

Not at all.  Where do you get that ?

Here is your post. It seems that I remember them better than you do:

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.

Well, that still holds, doesn't it ?

You make $20 of profit in the 3 cases.

You didn't answer this my post:

Okay, you borrow money at 0% interest rate (that means that you will have to return the same amount you borrowed, you name it), which is essentially the same if you just had that money. Inflation as well as deflation is 5%, your profit margin is 2%, when will you suffer losses, and when will you earn profits?

These are starting conditions (no inflation, no deflation, interest rate is 0). Go on with your answer.

[dinofelis]

You didn't answer this my post:

Okay, you borrow money at 0% interest rate (that means that you will have to return the same amount you borrowed, you name it), which is essentially the same if you just had that money. Inflation as well as deflation is 5%, your profit margin is 2%, when will you suffer losses, and when will you earn profits?

I just did.  Twice already.  You make $20 profit in the 3 cases.

Except that you refuse to consider that nominal interest rate is higher when there is inflation than when there is deflation.  That's my whole point.

If at 0% inflation, interest on a loan is 0%, then it will be 5% interest when inflation is 5% and it will be (funny) -5% when there is 5% deflation.

The point also being that you can't really have 5% deflation and 0% real interest rate (that is, negative nominal interest). But with your given starting points, that's what we have to consider, which is of course not really possible.

[tee-rex]

You didn't answer this my post:

Okay, you borrow money at 0% interest rate (that means that you will have to return the same amount you borrowed, you name it), which is essentially the same if you just had that money. Inflation as well as deflation is 5%, your profit margin is 2%, when will you suffer losses, and when will you earn profits?

I just did.  Twice already.  You make $20 profit in the 3 cases.

Except that you refuse to consider that nominal interest rate is higher when there is inflation than when there is deflation.  That's my whole point.

You didn't, and I already explained why (since in your examples there is no real deflation).

There is initially no inflation and no deflation, but zero interest rates, both nominal and real, so nothing favors either pro-inflation or pro-deflation view. I'm still waiting, explain to me how deflation will mirror inflation when they set in. Your profit margin is 2%, inflation and deflation are 5% each at the end of the production cycle.

[dinofelis]

There is initially no inflation and no deflation. I'm still waiting, explain to me how deflation will mirror inflation when they set in.

The only cases you can consider are constant, permanent, and expected inflation, or constant, permanent and expected deflation of course.  All the rest are suprise effects, like changing exchange rates and so on.

Unexpected inflation comes down to an unexpected drop in value of money.  As such, if you had previously exchanged money into something else (like production goods), then you will of course make a benefit when exchanging back into money after its value dropped.

Unexpected deflation comes down to an unexpected rise in value of money.  As such, if you had previously exchanged money into something else (like production goods), then you will of course suffer a loss when exchanging back into money.

That's pretty evident and trivial of course, but that doesn't say anything about sustained and constant inflation or deflation rate.

If you have $1000, and you buy soap with it, and then there is inflation, you were better off with the soap.  However, if there was deflation, you were better off keeping the $$.  So much is evident for an unexpected CHANGE in inflation/deflation rate.

[dinofelis]

You didn't, and I already explained why (since in your examples there is no real deflation).

Why do you say that if there is a constant deflation rate of 5%, there is no deflation

[dinofelis]

I think you should re-read this post:

https://bitcointalk.org/index.php?topic=975486.msg10900212#msg10900212

it is still the best example.  As the real interest rate is bigger than the considered inflation or deflation, we have positive nominal interest rates in the 3 cases, which is much more realistic.  As such, it illustrates much better the 3 cases of inflation, neutral, and deflation.

[tee-rex]

There is initially no inflation and no deflation. I'm still waiting, explain to me how deflation will mirror inflation when they set in.

The only cases you can consider are constant, permanent, and expected inflation, or constant, permanent and expected deflation of course.

So you don't what to deal with the simplest case and hope that if you complicate matters (making them hard to understand), it will somehow help you? Okay, there is 5% deflation (and 5% inflation) already under the way. Nominal interest rate (at which you borrow) is 0% under deflation (it can't be less than 0 by definition), and 5% under inflation. The question remains the same, i.e. if you borrow 1000$ and your profit margin is 2%, when will you be profitable, and when will you suffer losses?

[dinofelis]

So you don't what to deal with the simplest case and hope that if you complicate matters, it will somehow help you? Okay, there is 5% deflation (and 5% inflation) already under the way. Nominal interest rate is 0% under deflation, and 5% under inflation.

You cannot have 0% nominal interest rate under 5% deflation, and only 5% interest rate under 5% inflation.  Their difference should equal 10%, not 5%.

Otherwise we are in different conditions of real interest, that is, borrowing would be much more expensive in real terms under your deflation conditions than under your inflation conditions.  The whole point is that for every percent of inflation, the nominal interest rate will also rise with one percent, and for every percent of deflation, the nominal interest rate will also decrease by one percent.

So if you want to consider 0% interest rate at 5% deflation, you should consider 10% interest rate when there is 5% inflation.

But the case of 5% deflation, 0% interest rate, and 5% inflation and 10% interest rate, I want to do:

a) deflation case:

I borrow $1000 at 0%, I would have sold at $1020 (2% ROI) but because of deflation, I can only sell at $970.  $30 LOSS.

b) inflation case:

I borrow $1000 at 10%, I would have sold at $1020, but because of inflation, I can sell at 1070.  I have to pay $100 interest.  $30 LOSS again.


Why ?  Because the real interest rate is 5%, and my ROI is only 2%, so I LOST 3% in both cases.

c) neutral case:

I borrow $1000 at 5% (real rate), I sell at $1020, I have to pay $50 interest: again a loss of $30.

[tee-rex]

So you don't what to deal with the simplest case and hope that if you complicate matters, it will somehow help you? Okay, there is 5% deflation (and 5% inflation) already under the way. Nominal interest rate is 0% under deflation, and 5% under inflation.

You cannot have 0% nominal interest rate under 5% deflation, and only 5% interest rate under 5% inflation.  Their difference should equal 10%, not 5%.

Otherwise we are in different conditions of real interest, that is, borrowing would be much more expensive in real terms under your deflation conditions than under your inflation conditions.  The whole point is that for every percent of inflation, the nominal interest rate will also rise with one percent, and for every percent of deflation, the nominal interest rate will also decrease by one percent.

So if you want to consider 0% interest rate at 5% deflation, you should consider 10% interest rate when there is 5% inflation.

You are obviously trying to push you logic unto real things. Why should their difference be equal to 10%? Just to suit your considerations? The lower limit of interest rate in deflation is set to 0 (below that no one will lend to you), the lower limit in inflation is determined by the rate of inflation, so 5% interest rate under 5% inflation is quite possible. In fact, it can even be even lower than that.

I'm talking about what happens in reality. And in reality deflation as well as inflation has beginning.

[dinofelis]

You are obviously trying to push you logic unto real things. Why should their difference be equal to 10%? Just to suit your considerations?

Because nominal interest rate = real interest rate + inflation.

The real interest rate is the cost of borrowing money in real terms.  If we want to see the pure effects of inflation and deflation, we should of course consider the real price of borrowing money in the same conditions.

If you change the economic conditions between the two cases, you are not considering the effects of inflation and deflation any more.   You should change inflation and inflation ONLY ; ceteris paribus.

Otherwise, I could just as well change any other aspect of business arbitrarily and blame inflation or deflation:

"consider 2% inflation and the rent of my work shop is $500 ; now consider 3% deflation and the rent of my workshop is $900" or any other change in business condition.

No, the real cost of borrowing money (the real interest rate) has to remain constant of course.

The real cost of money is the one which will determine if your ROI will  be beneficial or not.  If your ROI is larger than the real interest rate, your activity will be beneficial ; if not, you will suffer a loss.

[tee-rex]

You are obviously trying to push you logic unto real things. Why should their difference be equal to 10%? Just to suit your considerations?

Because nominal interest rate = real interest rate + inflation.

What is real interest rate here and how is it different from inflation? I think you are trying to confuse the issue. I always thought the cost of capital (borrowing money) in real terms already included inflation. And then the nominal interest rate is equal to inflation plus profit margin for lenders.

Nevertheless, now let's proceed to the case where you don't borrow. 5% inflation and 5% deflation. You already have 1000$ and your profit margin is the same 2%. Will you be profitable under inflation in real terms, and will you suffer losses under deflation? You don't borrow, so you don't care about nominal interest rates (only about inflation).

[dinofelis]

I'm talking about what happens in reality. And in reality deflation as well as inflation has beginning.

In fact, a CHANGE is relative.

If we have a constant inflation rate of 10%, a real interest rate of 5% (so a nominal interest rate of 15%), and SUDDENLY the inflation rate drops to 2%, then this is entirely equivalent to having initially an inflation rate of 3% and suddenly having a deflation of 5%.

Indeed, if you had a ROI of 8% (so 3% higher than the real rate, you expect a gain of 3% hence), and you borrowed $1000 at 15%, you were going to sell at 1080 (ROI) + 100 (inflation) = 1180.  You would have to pay 150 interest.  So you would make $30 profit.

However, you have borrowed your $1000 at 15%, and now inflation turns out to be only 2%.  So you will only sell at 1080 + 20 = 1100.  However, you still have to pay your 150 interest ===> you make unexpectedly a loss of $50 because of the unexpected drop in inflation.

[dinofelis]

What is real interest rate here?

Nevertheless, now let's proceed to the case where you don't borrow. 5% inflation and 5% deflation. You already have 1000$ and your profit margin is the same 2%. Will you be profitable under inflation in real terms, and will you suffer losses under deflation?

We are running in circles. You always have to consider that you borrow, because you have to compare to what you would have obtained by NOT spending your money, but to place it on a savings account instead.

But if you like:

5% inflation (interest rate 10%).  If you place your money on a savings account, you would have obtained $1100.

If you do your thing, you would have sold at 1070.  You would have suffered a loss of $30 compared to placing your money.

5% deflation (interest rate 0%).  If you kept your money, you would have had nothing, so in the end you'd have $1000.

If you do your thing, you would have sold at 970.  You would have lost $30 as compared to keeping your money, again.

[dinofelis]

What is real interest rate here and how is it different from inflation? I think you are trying to confuse the issue.

I put up a few links earlier.

Real interest rate has nothing to do with inflation and deflation.

Real interest rate has to do with the price of borrowing value (no matter in what currency).
Inflation and deflation have to do with a specific currency: it is the price change of a currency.

Real interest rate is independent of a currency.  If the real interest rate is 5%, and I borrow you 20 houses during a year, it means I want an extra house back.  It is the market-determined cost of putting value at disposal during a year.

It has nothing to do with inflation or deflation of a specific currency.

The nominal interest rate is the real interest rate, corrected for the expected change of price of the currency at hand.  It is what you have to pay.

If the real interest rate is 5%, and I borrow you 100 eggs during a year, I expect 105 eggs back.

If the real interest rate is 5%, and I would lend $1000, and inflation is 2%, I know that next year, this $1000 is worth less, so in order to obtain really my 5% value, I have to ask you a nominal interest rate of 7%.

If there is deflation, and I know that $1000 will be worth 2% more next year, I'm happy with a nominal interest rate of 3% (because I will have my real value increase of 5%).

[dinofelis]

I always thought the cost of capital (borrowing money) in real terms already included inflation. And then the nominal interest rate is equal to inflation plus profit margin for lenders.

The cost of borrowing money in NOMINAL terms you mean (the actual rate you have to pay) includes, as you say, inflation and indeed, the expected profit margin for the lenders, which is exactly the real interest rate.

The profit margin of the lenders is indeed what is market-determined, between demand for borrowing value, and offer for borrowing value.  It is "the price for putting value at disposal during a year".  If we want to compare things, we have to keep this condition constant.

The REAL margin for creditors (the real price for debtors) is the real interest.  It is, as I said, determined by the offer by creditors and the demand by debtors.

If a potential creditor wants to put a certain value on the market, which is worth $1000 right now, and there is 10% inflation, he will only consider that he makes a benefit for everything ABOVE 10%.  Indeed, if he lends his $1000 right now, and he gets back $1100 a year from now, he cannot buy anything more with it than right now.  So there's no incentive for him to not buy the stuff right away and lend his money.  If the nominal interest he asks is 15%, he will consider that he got 5% VALUE back.  The real interest rate.  The nominal rate on the market will then be 15%, and the real interest rate 5%.

If the inflation is only 2%, he will be satisfied, in the same circumstances, with a nominal rate of 7%.  In the same market conditions, then, the nominal rate will be 7%, and the real interest rate still 5%.

Because the lender looks at his real rate to offer or not to offer.  So the offer on the money market will be determined by the REAL interest rate.  It is the same, for a lender, to get 15% if inflation is 10%, or to get 7% if inflation is 2%.  Offer will be the same in both conditions.

On the side of the borrower, you get a similar reasoning.  His demand will also depend on the real rate, not on the nominal rate.

This is why the market conditions actually determine the real rate.  

[tee-rex]

I always thought the cost of capital (borrowing money) in real terms already included inflation. And then the nominal interest rate is equal to inflation plus profit margin for lenders.

The cost of borrowing money in NOMINAL terms you mean (the actual rate you have to pay) includes, as you say, inflation and indeed, the expected profit margin for the lenders, which is exactly the real interest rate.

Then the real interest would be equal to nominal one in case there is no inflation?

So, as I understood your reasoning, you still consider as losses anything which the producer gets above the inflation rate but below inflation plus lenders interest, i.e. nominal interest? Even if he is not borrowing, right?

[dinofelis]

Then the real interest would be equal to nominal one in case there is no inflation?

Yes, that's the idea.  Because if there is no inflation or deflation, the monetary gain is the gain in value.  The "real interest rate" is the actual gain in value.  The nominal rate is the rate you have to pay, and which compensates for the inflation or deflation, if you borrow a monetary asset.  If there's no inflation or deflation, both are the same.

So, as I understood your reasoning, you still consider as losses anything which the producer gets above the inflation rate but below inflation plus lenders interest, i.e. nominal interest? Even if he is not borrowing, right?

Yes, because you should consider that he's borrowing.  The point is that you have two investment options:
1) doing your thing USING the money
2) lending out the money (which comes down to putting it on a savings account, say).

If you get more by putting the money on a savings account rather than doing your thing with it, doing your thing is a losing affair.

Let us assume no inflation or deflation for the moment, just to illustrate the point.

Say that you have $1000.- lying around.

You have 2 options:

1) putting that $1000.- in a savings account with an interest rate of 5%

2) doing something with it with a return on investment of 2%

Obviously, if you go for 2), you make 3% loss as compared to what you would obtain if you didn't actually do something with the money but put your money in a savings account, right ?

If you do an investment, and you get less from it than you'd get from a savings account, you're actually making losses.  That can seem strange, but it becomes more obvious if you consider that you have to borrow the money to do your thing.

Now of course I'm neglecting something here, and that is the margin taken by the bank, who gives a lower return on savings accounts than it takes on loans.  True.  I'm taking out the bank as an intermediate, and consider that a savings account is directly a loan to someone.  So it is true that you get cheaper off using your own money than having to borrow (because of the margin taken by the bank).  The "real interest rate" for savings accounts is smaller than the real interest rate for loans.  The difference goes in the bank's pockets.  But of course the reasoning here is somewhat simplified, to get down to the essentials of the effects of inflation and deflation, without working out an entire business plan

[zimmah]

Look at games like league of legends or heroes of the storm. When they release a new hero, it's the most expensive hero for a few weeks, after a while, the price drops, and after more time has passed the price drops again.

Even though everyone knows the price will drop if you wait, you can see a lot of people actually buy the hero on day 1. Why? Because they can afford it and they do not want to wait. Others may wait a bit, but get it after 2 weeks once the price has dropped, because they feel waiting two weeks to get 33% off is worth it. Others may even wait 3 months to get 50% off.

Having something early is worth it to some, so deflation isn't that bad in a highly competive and "status symbol" driven economy. Why else do people buy a BMW while they could also have bought a cheaper ford? Exactly because it is expensive, and it shows the world you can afford an expensive luxury car and a brand new model to boot.

A 2 year old model Bentley is a lot less valuable than a brand new model of a similar serie. So, deflation in a sense can already be observed, and it's not breaking the economy at all. And that's even for items we don't even need.

Let's look at food now, and toilet paper, razors (for shaving), toothpaste. You can't just say "oh, I will just wait until next month, because food will be 5% cheaper by next month". Yeah, problem is if you don't eat you'll fucking starve before you get to see the 5% reduction in the first place.

[tee-rex]

So, as I understood your reasoning, you still consider as losses anything which the producer gets above the inflation rate but below inflation plus lenders interest, i.e. nominal interest? Even if he is not borrowing, right?

Yes, because you should consider that he's borrowing.  The point is that you have two investment options:
1) doing your thing USING the money
2) lending out the money (which comes down to putting it on a savings account, say).

If you get more by putting the money on a savings account rather than doing your thing with it, doing your thing is a losing affair.

Do you understand that by saying this you are losing touch with reality (and simple reason at that)?

First, if you put your money into a savings account, you won't be able to get nominal interest rate (NIR) in return, since it is the rate you borrow money at. Strictly following your logic, you can put the money on a savings account only at the rate of inflation (you see where I lead you to?), since lenders happen to be the same ones who take money from you, but, as you said, the NIR is a sum of inflation plus real interest earned by lenders (not you), i.e. their profit margin. This is where your logic fails.

Second, a business that works on its own capital only, appears to be always less profitable (since you subtract the cost of (non)borrowed capital from its revenue, and thus profit) than a business that actually borrows capital and earns more revenue. But in reality the former may get more money in profit (since they don't have to pay interest on borrowed capital) than the latter. This is where reason ultimately leaves you.

Third, if you, nevertheless, insist that we should necessarily compare a profit margin earned by a non-borrowing business to that of money lenders (to see if it is profitable), why not then compare them to a profit margin of, say, drug dealers? In this case, both enterprise and money lenders (which are just another business) will be conspicuously unprofitable, right? This is the point where your idea becomes evidently absurd.