Falling Prices

7 Key excerpts on "Falling Prices"

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  eBook - PDF

  Introduction to Economics

  Social Issues and Economic Thinking

  • Wendy A. Stock(Author)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  Delayed purchases will cause a decline in aggregate demand in the current period, which in turn generates reductions in production and output that can push an economy into recession. During the Great Depression, for example, the price level declined by an average of 10 percent per year. In the face of Falling Prices for their products, many producers could not afford to continue production. In the agricultural sector, the prices of food and grain fell so much and so quickly that many farmers found that it was not even worthwhile to have their crop harvested. Instead, many of the crops were left to whither. 4 2 0 2 4 6 8 10 12 14 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Inflation Rate Year Figure 7.2 U.S. Annual Inflation Rates Source: Author’s calculations from BLS data. Values represent December–December changes. The dashed line represents the average inflation rate over the period (3.8 percent). Disinflation is a period of positive but falling inflation. Disinflation indicates a slowing of the rate of price increase in the economy. Deflation is negative inflation. Deflation indicates a period of declining prices of goods and services. M e a s u r i n g P r i c e s a n d I n f l a t i o n 1 2 3 Although the United States has managed to keep inflation fairly steady over time, many other countries in the world struggle with high and volatile inflation rates. Figure 7.3 illustrates annual inflation rates by country in 2008. North America and Greenland, Western Europe, Australia, Japan, and several countries in Northeastern Africa had inflation rates below 5 percent in 2008. Alternatively, Venezuela, Iran, Ukraine, Burma, and several African nations faced inflation above 25 percent, includ- ing Zimbabwe’s 11.2 million percent inflation rate for the year. Deflation in the Housing Market In the mid-2000s, the United States saw a dramatic change in hous- ing prices. After rising steadily for many years, U.S. home prices took a dramatic downward turn.

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  Law and Inflation

  • Keith S. Rosenn(Author)
  • 2015(Publication Date)
  • University of Pennsylvania Press

    (Publisher)

  INFLATION'S CAUSES AND CURES The term inflation is often used loosely in English to mean anything from pomposity to increases in money, income, and profits. 1 For the pur-poses of this book, inflation is used to refer either to a sustained rise in an economy's general level of prices or to a corresponding fall in the domestic purchasing power of an economy's currency. This working definition im-plies that inflation is a dynamic process in which the aggregate level of prices is moving upward over time while the purchasing power of money is in corresponding decline. It does not mean that all prices are moving upward uniformly, nor even that all prices are moving upward. It does mean that an economy is undergoing inflation when it presently costs more to purchase a representative sample of goods than it cost in the past. Inflation and its opposite, deflation, describe changes in a nation's internal price levels or its currency's domestic purchasing power. Changes in a currency's external purchasing power occur through adjust-ments in the foreign exchange rate. When the value of country A's cur-rency declines relative to the currency of country B, there has been a devaluation of country A's currency. Correspondingly, there has been an upward revaluation in country B's currency relative to country A. In com-mon parlance references to changes in internal and external purchasing power of a currency are frequently commingled; it is not uncommon to find courts confusingly referring to devaluation when they really mean depreciation in domestic purchasing power. 2 In the long run, countries experiencing inflation rates higher than those of customary trading part-ners will be forced to devalue; however, in the short run, it is frequently possible for countries to maintain the same exchange rate despite sub-stantial domestic inflation, or to devalue by less than the inflation rate differential.

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  The Global Curse of the Federal Reserve

  Manifesto for a Second Monetarist Revolution

  • B. Brown(Author)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Moreover, in the context of the gold stand- ard world, the fall in prices in the immediate term would mean a lower cost of mining the yellow metal, which together with its fixed price in money terms would produce some increase in gold supplies, favouring some recovery of the general price level over the long run. In history it is possible that the so-called ‘great deflation’, which spanned much of the 1870s and 80s and was a global phenomenon, could be partly explained by such a process of a rising savings rate. Savings were increasing as the populations in Western Europe and the US started to provide for their retirement in some cases through national pension schemes. Britain and France swung into a huge sav- ings surplus as domestic investment opportunity fell behind savings (with lending or investment abroad booming). From the lower level of prices reached at the end of 1880s, price recovery had surely become more likely than further price level decline. Underpinning such a probability calculus would have been the outlook for revived mone- tary growth. Lower costs of mining (in part reflecting the fall of prices generally of inputs) played some role together with new discoveries in driving gold production higher. The decade or more before the out- break of the First World War was essentially one of significantly nega- tive risk-free rates in real terms (see Chapter 1, p.13 for analysis of this historical fact in a US context). The last example here of false positives (on deflationary disequilib- rium), as signalled by Falling Prices, is found in a situation where there are already built-in expectations of price level decline. These (expecta- tions) might have formed over a long period of time and the central bank might be seen as piloting a monetary course which would be con- sistent with this steady-state decline continuing. Indeed in one essay,

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  The Reform of Macroeconomic Policy

  From Stagflation to Low or Zero Inflation

  • J. Perkins(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  But the term ‘deflation’ has usually been employed in the past by economists to mean a fall in output or employment. It is true that in the 1930s Falling Prices often accompanied a contraction of output and employment. But there is no presumption that this will 180 The Reform of Macroeconomic Policy be the normal course of events. Indeed, unless these two uses of the term ‘deflation’ are kept separate there is a risk that a misconception will arise that they are inevitably associated with one another: that Falling Prices are always accompanied by falling output or employ- ment, and that falling employment or output cannot occur without Falling Prices. It is especially important to distinguish between these two possible uses of the term ‘deflation’ as very different policy meas- ures will be required to deal with falling output or employment accompanied by inflation from those that will be required for a situ- ation of falling (or low) inflation combined with constant or rising employment or output. (There have been a few cases of the term ‘disinflation’ being used to mean ‘a situation of Falling Prices’. But that term was coined to mean simply ‘the reduction or elimination of inflation’; and it does not, therefore, seem desirable to extend its meaning in that way.) In what follows, therefore, the term ‘negative inflation’ will be used to mean ‘a falling price level’. The term ‘deflation’ will be reserved to mean ‘a contraction of output or employment’ – at least relative to potential. Measured inflation and actual inflation In a situation of low inflation, and with many central banks being committed to achieving the objective of ‘price stability’, there may well be periods where the general price level is actually falling. For if the central banks are successful in achieving something close to price sta- bility over a period, it would imply that the general level of prices will be falling about as much and as often as it will be rising.

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  Trading Economics

  A Guide to Economic Statistics for Practitioners and Students

  • Trevor Williams, Victoria Turton(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  4 Inflation Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. Milton Friedman 1 WHAT IS INFLATION? Inflation tells us the changing (increasing) price of a range of goods or services; basically how much of something we can get for our money. The rate of change of prices – the speed at which the price of goods and services that are bought by households or businesses alter – is called inflation. But prices can also fall, in a process called deflation, sometimes termed negative inflation. Inflation is more common than deflation, or at least it has been in the last 50 years or so, and so it has become associated with changes in the price of goods and services. Historically, however, price falls were as common as price rises, as we will see later. Both inflation and deflation have advantages and disadvantages, which we will explore in more detail later in this chapter. THE HISTORY OF INFLATION Inflation has been around for a long time, but, as Figure 4.1 shows, the level of prices (the index) really only rose consistently and sharply in the UK from the 1970s onwards. This was after the US came off the gold standards and the Bretton Woods system of fixed exchange rates, which had prevailed after the Second World War, ended. Money was now backed by government fiat and trust rather than by gold. And exchange rates were no longer fixed but allowed to float freely. This seems to have led to a rapid rise in the level of prices or, in other words, to the Retail Prices Index. Before that, for hundreds of years, the level 1 Friedman, M., The Counter-Revolution in Monetary Theory (1970). 100 Trading Economics Retail Price Index (1987 = 100) 0 10 20 30 40 50 60 70 80 90 100 1264 1296 1328 1360 1392 1424 1456 1488 1520 1552 1584 1616 1648 1680 1712 1744 1776 1808 1840 1872 1904 1936 1968 2000 Figure 4.1 Price index over time.

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  Microfoundations and Macroeconomics

  An Austrian Perspective

  • Steven Horwitz(Author)
  • 2000(Publication Date)
  • Taylor & Francis

    (Publisher)

  These downward relative price effects do not reflect changes in any real variables on the goods side of the market. Instead, they reflect distortions coming from the money side of the market, and as such, serve no efficiency-enhancing role in the larger view. Of course, general downward price movements are desirable given the excess demand for money because, if they do not occur, more significant quantity adjustments will have to take place. But money-induced declines in prices are not necessary if the banking system can maintain monetary equilibrium, and even if such declines should take place, they would be less harmful if they avoided relative price effects during the fall in the price level.

  Such relative price effects create many of the same problems we discussed with respect to relative price effects during inflation. When relative prices are moving around for reasons both unconnected with the underlying variables of the goods side and avoidable through a proper monetary regime, their epistemic function is undermined and the monetary calculation process that is necessary for making rational economic choices is compromised. By divorcing prices from the underlying variables, deflation makes monetary calculation more difficult, which suggests that more errors will be made in the resource allocation process. To the extent that such mistakes involve irretrievable costs, then the relative price effects of deflation become an additional source of economic waste.

  In particular, we might expect to see two specific kinds of relative price effects during deflation. One would be the understating of the profitability of firms. An unexpected fall in the price level will shrink the nominal revenues obtained in the future from the inputs priced at today’s historical cost. As firms’ balance sheets look more dismal, they may be led to make adjustments in their production processes (including, but not limited to, laying off workers) that will later be seen to be an erroneous reaction to a temporary phenomenon. Any irretrievable costs of adjustment are wasted. A second pattern of relative price effects would be those associated with the interest rate. During the initial excess demand for money, the market rate will be above the natural rate. This will encourage firms to shrink the length of their capital projects, that is, to squeeze together or eliminate stages of production. Firms that decide to make such decisions unaware that the deflation, and not any real factors, is causing the rise in rates may later regret the decision and will have wasted any irretrievable adjustment costs. As the market rate of interest becomes disconnected with underlying variables, due to the banking system’s inability to maintain monetary equilibrium, it will induce precisely these kind of distortions into the capital structure. In the Yeager and Leijonhufvud literature on monetary disequilibria, there is little mention of capital structure effects, but to the extent such effects are expected to occur in inflationary monetary disequilibria, why would we not expect them during deflation?11

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  Paper Money Collapse

  The Folly of Elastic Money

  • Detlev S. Schlichter(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  14 and will counteract some of the effect from higher productivity. However, in a deflationary environment, gold now competes to some degree with genuine investment goods. Money has a small positive yield. This in turn lowers the costs of holding money again.

  And there is another aspect: The demand for money should in this scenario not remain unchanged but in fact rise. If the economy produces a larger quantity of goods and services than before, and money users get, on average, wealthier, it is only logical to assume that the money users want to hold more purchasing power in readily spendable form. Indeed, it would be somewhat unrealistic to assume that, although more goods and services are now on offer, the individual money user would not have a higher demand for the flexibility to spontaneously engage in economic transactions. To the extent that this is the outcome, a monetary system with a money commodity of essentially fixed supply will indeed experience secular deflation. A growing economy with an entirely inflexible money supply will exhibit a tendency for prices to decline on trend and for money’s purchasing to steadily increase. But the key question now is why should this be a problem?

  We have already seen that, historically, secular deflation was rather minor and that it certainly never appeared to present any serious economic difficulties. No correlation between deflation and economic recession or stagnation is evident under commodity money systems. I will now try to show that there are no reasons on conceptual grounds to consider deflation to be a problem either. There is nothing fundamentally disruptive or problematic about a gradual trend decline in the price level.

  First, for the single purpose of rational economic calculation based on money prices, an ongoing moderate deflation is neither better nor worse than the ongoing moderate inflation that is widely advocated today under state-managed paper money. The on-trend decline in prices will simply come to be expected by economic agents and be part of their economic planning.

  The widespread belief that deflation hurts borrowers on the loan market is unfounded. This view stems from the specific situation of an economic crisis, in which a sudden and unexpected drop in many prices can cause problems for those in debt, as it requires more real goods and real services to repay a nominal loan amount. This would provide a windfall gain for the creditors. But what we discuss here is not a sudden, crisis-induced (or money demand–induced) deflation but trend or secular deflation as a feature of commodity money, which emanates from rising productivity and thus gradually rising money demand. And in this context, there is no reason to believe that, when agreeing to the terms of a loan, borrowers would disregard probable trend deflation any less than lenders disregard probable trend inflation in today’s monetary system. Unexpected inflation is usually good for borrowers and bad for lenders and unexpected deflation is usually bad for borrowers and good for lenders (as long as the borrowers can still pay), but any discernible, moderate, and stable trend in either direction will simply be anticipated and incorporated into the market rate of the loan agreement by both sides.15

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