Technology and deflation

A couple of weeks ago, Planet Money tried to explain why deflation is a bad thing.  They basically gave two answers:

1)  Both inflation and deflation can spiral out of control, but a strong central bank has more things that it can do to control inflation (mostly raise interest rates).   The Fed can’t lower interest rates below zero, and it’s getting pretty close that wall already.

2) When people expect prices to drop, they don’t want to buy things now that they can get cheaper next year.  And businesses don’t want to invest today in order to make things that they’ll have to sell for less next year.  So consumption and investment both drop.

The first answer makes sense to me, but I’m not entirely convinced by the second one. It certainly seems to apply to houses.  But we’ve been living in a world for the past several decades where consumer electronics get better and cheaper every year.  Everyone knows that if you wait for the next Apple upgrade cycle, you’ll be able to buy an iPod that is smaller, has new features, and costs less.  But it hasn’t stopped people from rushing out to buy.

So, is the overall economy more like buying a house, or buying an iPod?  Well, there’s not much that people buy other than houses that are investments, rather than consumption.  And I’m not convinced that the reason people aren’t buying cars is that they think they’ll be cheaper at a future date — rather, it’s that they’re afraid to borrow when they might lose their job (or can’t get credit).

Am I missing something?

10 Responses to “Technology and deflation”

  1. amy Says:

    Yep. You’re assuming that the Mad Consumer still lives, but that’s already changed and will continue to change as credit withers. Think back to your youth, when money was a scarce thing and people were careful with it, because there wouldn’t be piles more if you lost it. We were much less impulsive then.
    Not a lot is like iPods. Even iPods are frequently not like iPods. I’m a former Mac IT person and am fully acquainted with the “must get new gadget before it leaves the rarefied air of Cupertino” syndrome, but I got my first iPod with a screen last month. I’m typing this on a 4-year-old G4 iBook running an old OS — my work machine — and won’t buy anything new or upgrade until things actually stop working, even though I’m good for cash. I went and admired the iPhone, but come on. $600? $300? And that crazy contract? For a _telephone_? I’ll wait till you can buy them in the drugstore.
    Think of most things we buy that cost more than a few bucks — furniture, cars (yep), TVs, office equipment, vacations, new windows, landscaping, fancy duds, playsets. If it’s August and we’re pretty sure the thing will be 15% cheaper by Christmas, an awful lot of people will sit tight and wait for a deal. That’s not true for must-have things, but — well, think how people with a good cushion of cash on hand are already treating the fire sales. Sure, the jewelry’s cheap now, but come January you’re going to see stuff at desperation prices. And going-out-of-business prices. May as well wait. (I don’t think Q4 is going to be the bottom, btw. People are still holiday shopping. But I think we’ll have a retail ghost town the first half of next year.)
    I think people will sit tight and wait for price drops so long as a) they don’t need the thing immediately; b) they’re neither rich nor suffering from the delusion that they’re rich. That delusion’s going to be a lot harder to come by for a long time.

  2. Elizabeth Says:

    I agree there’s going to be a lot more waiting until the current one is totally broken/unusable rather than buying the replacement just because it’s cool, but I’m not convinced that falling prices is the reason. If I just don’t need a left handed humdinger, I still won’t need it at 20% off.

  3. Ross Says:

    What Planet Money left out is that during deflation, as prices fall the value of money increases. You can buy more with each dollar. That’s not bad for people with a secure fixed income. Retirees with with a defined benefit plans and many civil servants fall into that category. Because money is more valuable, there is a tendency to not spend it and demand drops further leading to reduced wages etc. There is an additional problem in that we are a debtor nation and that means that in a deflationary period, debt’s have to be paid with dollars that are more valuable than the ones that were borrowed. If it really comes to pass, expect to see a return of “lay a way” plan buying, which was prevalent pre WWII and still common in my childhood instead of credit purchases.
    Central banks can effectively reduce effective interest rates below zero by printing money, allowing you to pay off debts with cheaper money. It is a delicate job and I have every confidence that they will screw it up.

  4. Mykal Says:

    I didn’t really buy the arguments much either. They didn’t seem to get to far from inflation is good and deflation is bad because I said so!

  5. amy Says:

    True enough about the humdinger, Elizabeth. Still, this is about things people don’t need immediately, or perhaps at all, but want. Say you want to replace some carpeting with wood flooring — the carpet works perfectly well, but you likes you some wide-board pine. Get it installed now, it’ll run you $10K. Wait till March, and you can probably get it for $7K. For three thousand bucks with extra muscles in them, a lot of people will wait, then buy — and then they’ll take that $3K and buy something else cheaper.
    You’ll also find people waiting for things to come down to price points where they’re willing to buy. I’ve done this myself with furniture. There’s a very nice furniture store where I window shop every so often, and I’ve been wanting a good reading chair for a long time. I haven’t bought because I’m not in the market for $1500 armchairs. I went in a few months ago, as things started to crumble economically, and saw a nice chair marked down to maybe $700 (I can’t remember what it was, exactly, but it was a cut that left the price much higher than I’d pay). Well, it was plain to me that things weren’t going to get better in the money world anytime soon, and furniture moves slow. I figured I might be able to cut to the chase, and offered $300. Sold.
    Keep in mind, though, that even if there is real deflation, many prices are unlikely to show the damage. I don’t see that we can avoid significant inflation; we’re running the printing presses like crazy, and pumping in a serious percentage of current money supply. Put the two together and it may be difficult to tell what’s going on without looking at items like food, because inflation will show up readily there.

  6. liz Says:

    I think people will make impulse buys and “gotta have it now” buys for things they still feel they can afford…hard-cover books for my own example, but will put off purchases of bigger ticket items for as long as they can right now. Cars, refridgerators, etc.

  7. Ross Says:

    Talking about delaying purchases as a bargain hunting device misses the point. An expanding, slightly inflating economy is what keeps unemployment low. If everyone waits for a bargain, retail sales plummet and retail salespeople (who are less likely to have health insurance etc) will be out of work and neither able to shop nor pay their mortgages. If no one is buying, manufacturer’s stop manufacturing. There will not be a lot of jobs for new graduates etc. The classic solution to deflation is Keynsean pump priming but it is hard to get the money out fast enough to abort a downward cycle. The fastest ways are extending unemployment and block grants to states so that they don’t fire people in order to balance their budgets. Infrastructure projects whether necessary or “pork” have a long lead time and historically have not gotten money into the economy until after the recession is over. The argument for supporting GM and Ford now is not that it will save them but that by keeping them afloat, however poorly managed they may be, the government prevents an immediate further contraction in the economy. If by some miracle, the money produces a recovery, that’s great but all one should really hope for is that their crash is delayed until the rest of the economy is better.

  8. jen Says:

    I’m not sure I can really attribute my current attitudes towards money to anything based in reality. To me, because I am so fearful of unemployment, no amount of money saved is enough. (Especially when you factor in COBRA payments, I would have to save probably a year’s salary to feel like I could really weather a layoff. It’s not happening.)
    So I’m not waiting for prices to drop below a certain level. I’m just not spending any money on anything. Even when shopping for groceries, which are a moderate expense at our house, I have become obsessed with saving that 10 cents on each box of pasta. It’s stupid! And I can’t stop myself!

  9. amy Says:

    “If everyone waits for a bargain, retail sales plummet and retail salespeople (who are less likely to have health insurance etc) will be out of work and neither able to shop nor pay their mortgages. If no one is buying, manufacturer’s stop manufacturing. There will not be a lot of jobs for new graduates etc.”
    Yes, that’s the point Elizabeth was drawing out. I’m trying to demonstrate why people do in fact behave the way Planet Money describes in deflationary times.
    “The classic solution to deflation is Keynsean pump priming but it is hard to get the money out fast enough to abort a downward cycle”
    Actually the feds are doing a tremendous job of this — so tremendous that people with money are seriously concerned about inflation, which will happen (and will mask the decline in the constant-dollar value of long-life goods) — actually it’s already been rollicking along but it’s likely to tick up substantially. My brokerage is touting inflation-protected funds now.
    Also, the rest of the economy is in trouble for much longer than it’d take the Big 3 to become competitive. We will throw money, it will vanish, Detroit will finish its collapse. It’s New Orleans North.
    Jen, the bargain-hunting impulse isn’t stupid at all. I can’t afford my COBRA either, and wake up thinking, “This is ridiculous. I can’t afford this house. I should move us to the condo and have good health insurance.” But thanks to the criminally naive bleeding-smalltown-hearts housing/development policies our local government has, my condo, which was once in a happy, safe student area, is rapidly being engulfed by a slum imported from Chicago, and it’s only a matter of time before some condo-dwelling medical student gets ambushed by a thug waiting on an open-air stairwell. So no, I don’t want to move my kid there. I’ll probably end up rolling the dice, shifting to inadequate insurance, hoping I don’t get really sick, and hoping that if I do, my catastrophic policy will actually pay out. That, or I’ll take out massive student loans and spend them on health insurance. I haven’t sat down to do the numbers yet and figure which makes more sense.

  10. urbanartiste Says:

    I may be way off the mark here, but for the past 5 years my salary has not gone up comparable to the cost of living. Housing prices skyrocketed because people felt they could charge whatever the hell they wanted. Now the market is flooded with homes, not only because of foreclosures, but because of the excessive construction of urban sprawl.
    As a child of the 1980s-Reagan-era of consumption, I recall the mindset of living off credit. Competing with the Joneses morphed into an entitlement mentality. There will always be a small percentage of people that have to buy some new gadget or fashion item first, but I think people are really starting to get back to basics – saving and not spending. Personally, I don’t think the planet can sustain the type of consumption going on around the world, so for me this is a good thing.

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