The theory explaining why deflation is worse than inflation goes something like this:
- The price of goods and services will be less tomorrow than it will be today.
- Therefore the consumer will put off today's purchases until tomorrow because he'll get a better price then he can today.
- Since this will be the case every day, consumers will never buy anything, and the economy will tank.
- It assumes that the only value of a consumer purchase is contained in the price paid. This is obviously in error as a purchase is made to utilise. Take computers as a concrete example of this. The computer I buy today, I can be certain I will be able to purchase next month for less, and the month after that for even less. Yet I still make the purchase because I buy it to use it.
- It also ignores a distinct counter example of this: the United states in the late 19th century. During this period the purchasing power of the dollar was increasing and the economy was booming.
The most widely cited example used to back up the "deflation is bad" argument is the disastrous results of the Federal Reserve's monetary contraction policy during the Great Depression.
- The significant point here is that the deflation in this case was artificially introduced by government action, not by natural market forces.
- To understand why governmental meddling with the money supply is harmful to an economy, one must understand how the meddling takes place.
- If, for example, one day the government dropped a trillion dollars from helicopters, or mailed $300 checks to every person in the US, or magically added a zero to every dollar amount in the country, not much would happen - it would be a fairly meaningless gesture because the economy would be able to instantly adjust to the pecuniary alteration.
- This is not the way they do it. What happens instead is they (basically) give a bunch of newly-printed cash to politically connected cronies and the financial adjustment happens slowly as the additional cash makes it's way through the economy. During the time between it's introduction and it's saturation, many people are going to make incorrect assumptions about the relative scarcity of goods and services because of the new money. This causes resources to be poorly allocated, and that is what detracts from the wealth of the economy.
- In the case of artificial deflation, again, the removal of cash from the economy does not happen instantly everywhere. It occurs at specific points in the economy and ripples through, causing damage by inducing people to misallocate their resources.
- Inflation transfers wealth from creditors to debtors by making the debt owed less valuable.
- Deflation transfers wealth from debtors to creditors by making the debt owed more valuable.
- There are more voters who are debtors than there are who are creditors.
- It is therefore in the self interest of the politician to pander to debtors by preventing deflation.