Deflation

There is ominous talk of deflation. According to the Financial Times:

In theory, such deflation could be good for the economy, as it releases money for consumers to spend on other products. But as Andrew Brigden of Fathom Consulting warns, deflation can also take a malign form. “The risk is that people don’t spend because they think prices will be yet lower in the future and that sets off a negative spiral,” he says.

Temporary drops in prices are unlikely to have that effect. But Mr Brigden thinks the combination of falls in commodity and house prices with weak demand means that US headline inflation is likely to go negative next spring and stay that way for months, dropping as low as minus 3 per cent. “When deflation goes on for the best part of a year, expectations are more likely to become entrenched,” he says.

In other words, if you know something is going to be cheaper in a few months or a year, you are not likely to buy. Why is deflation so bad? Deflation was one of the features of the Great Depression.

What can be done? The Penny Pincher is not going to encourage you to go out and spend. You are still better off paying off debt and getting rid of interest charges. Learn to live within your means, and once that you have done that, then spend frugally on quality products (preferably used).

Consumers don’t have to spend. Governments can spend in infrastructure. I am happy to see that Barack Obama is going to be taking this approach. Rather than sending rebate cheques to consumers, he will get the state to invest in its infrastructure. This according to the Globe and Mail:

WASHINGTON — U.S. President-elect Barack Obama on Saturday outlined his plan to create 2.5 million jobs in coming years to rebuild roads and bridges and modernize schools while developing alternative energy sources and more efficient cars.

“These aren’t just steps to pull ourselves out of this immediate crisis; these are the long-term investments in our economic future that have been ignored for far too long,” Mr. Obama said in the weekly Democratic radio address. The economic recovery plan being developed by his staff aims to create 2.5 million jobs by January 2011, and he wants to get it through Congress quickly and sign it soon after taking office.

He called the plan “big enough to meet the challenges we face” and said that it will jump-start job creation but also “lay the foundation for a strong and growing economy.”

This is good policy. He will address the main danger (deflation) without having to rely on consumers sinking deeper into debt. This way, consumers can focus on spending less, while the state picks up the slack by investing into the infrastructure that will improve the lives of all. Just what the Penny Pincher recommended.

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2 Responses to Deflation

  1. Allen Taylor says:

    Nice writing. You are on my RSS reader now so I can read more from you down the road.

    Allen Taylor

  2. Joshua Lacey says:

    What America needs is to become energy independent.Iran just asked OPEC to reduce production by yet another 1.5 million barrels per day.This past year and the record gas prices played a huge part in our economic meltdown and seriously damaged our society.We keep planning to spend BILLIONS on bailouts and stimulus plans.Bail us out of our dependence on foreign oil. Make electric plug in car technology more affordable. It cost the equivalent of 60 cents a gallon to drive an electric plug in car. The electric could be generated from wind or solar. Get with it! Utilize free sources such as wind and solar. Stop throwing away money on things that don’t work. Invest in America and it’s energy independence. Create cheap clean energy, create millions of badly needed green collar jobs. Put America back to work. It is a win-win situation. We have to become more poractive citizens, educate ourselves and demand our elected officials move this country forward into the era of energy independence. Jeff Wilson’s new book The Manhattan Project of 2009 Energy Independence NOW outlines a plan for America to wean itself off oil. We need a plan and we need it now! http://www.themanhattanprojectof2009.com

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