Everything Must Go!
When I saw the headline “Consumer Prices Fall by Record Amount” I was ready to move into full-blown panic mode. Everyone likes to spend less, of course, but deflation is a bad thing and record deflation could be really terrifying. Fortunately, this turns out to be one of those situations they had in mind when they came up with the “core” inflation statistic that eliminates consideration of volatile commodities like energy:
Energy prices led the decline, falling 8.6 percent in October as the price of gasoline continued its steady slide from highs of more than $4 a gallon. The costs of transportation fell 5.4 percent while clothing prices fell 1 percent. [...] Even excluding volatile food and energy prices, prices dropped 0.1 percent in October. It was the first such decline in more than two decades and raises the specter of deflation as the economy contracts and demand for goods and services across the board plunges. [...] Mr. Sullivan added that he expects core prices, which are up 2.2 percent this year, to continue to fall back, but he does not expect them to slip into negative territory.
That’s not nearly as terrifying. Still, any core deflation at all is rare — we got through the last two recessions without any, which is how you know they were relatively mild recessions.
23 Responses to “Everything Must Go!”
Register
RSSLogin
Topic Cloud
ArchivesBlog RollAbout Matt YglesiasContact Me
Donate
November 19th, 2008 at 10:34 am
I’m a total cipher on economics and so this might be a stupid question, but why is this a bad thing? Inflation devalues our currency, making goods cost more than they did X number of years ago, so isn’t an across-the-board price cut good for us?
November 19th, 2008 at 10:35 am
What is this BS with excluding “highly volatile” food prices. Why don’t they use a nice simple factor of, say, a 3-year moving average? When was the last time you paid less for food than you did 36 months ago? Especially in adjusted/constant dollars.
November 19th, 2008 at 10:40 am
why is this a bad thing?
It’s not really, so long as it doesn’t turn into a deflationary spiral, i.e., people substantially stop spending because they’re anticipating further price drops.
November 19th, 2008 at 10:53 am
The fall in Core CPI by 0.1% seems driven in large part by large declines in prices for new (-0.5%) and especially used (-2.4%) cars and trucks. The auto industry once more playing a major role in developments. I don’t think these price declines are going to be very persistent.
November 19th, 2008 at 11:32 am
So, Matt, after entering “full panic mode” what might you have done?
November 19th, 2008 at 1:16 pm
This question is asked on every single economics blog about every few months. And no one ever has a good answer to this.
November 19th, 2008 at 1:21 pm
Deflation is absolutely coming. Everyone is waiting for prices to fall–hell, I’m doing it and I’m well off.
More than that, nobody’s got a lick of wage protection and everybody’s in debt. They’ll have less coming in even if they’re not fired, and be more unwilling than ever to let it go.
The deflationary spiral is going to be VERY ugly. The only thing that might prevent it is credit cards. They’ll allow consumers to be irresponsible–as long as they can pay the minimum, they’ll continue to be a little too careless on their necessity spending, and give in much more to their unnecessary impulse buying. I have no idea what the long-term cost will be (I’m thinking it’ll look like a generation of people indentured to Mastercard), but as long as credit card companies contimue to be able to make money by enabling fiscal recklessness, we may not see a true deflationary spiral.
November 19th, 2008 at 1:48 pm
DTM,
Thanks for the explanation. I get what you’re saying about anticipation of low prices depressing consumer spending; sounds an awful lot like some of the recent gas scares, especially in the wake of Katrina (people worry there’s going to be a gas shortage, so they go to the pumps in droves and… yeah.). I get the impression these self-fulfilling prophecies come up a lot in economics.
If there was ever a time for price depression, I suppose the holiday season is the best we could ask for?
November 19th, 2008 at 2:19 pm
This question is asked on every single economics blog about every few months. And no one ever has a good answer to this.
If no one ever has a good answer then there must not be any economists around. I’m not even an economist and I know the answer (or at least the theory). If the inflation in food and energy is a real, long term change and not a short term fluctuation, it will show up in other sectors after some time lag. Therefore, leaving it out is at least as effective (and easier) than trying to smooth out the short term flucuations. And they do always report both numbers so if you personally think that the food and energy components reflect basal changes rather than flucuations, you have the knowledge to act on that.
November 19th, 2008 at 2:40 pm
I’m no economist, so forgive my ignorance. I’m really looking for an answer to this question.
It seems that much of the boom of the past 7 years (post dot.com bubble) has been fueled by the rise in residential real estate values, with all the imaginative borrowing and consumption that went along with it. This has allowed numerous consumer sectors like electronics, tourism, automobiles, and such to do pretty well.
Now that the pyramid has toppled, shouldn’t we expect prices to fall? Or is the increased cost of everything (arguably fueled by the easy money) expected to stay high while people’s personal wealth (and face it, for most people that means the value of their home) can be decreased by 10-50% (or more)?
Seems like the bubble contraction necessarily demands that the prices that rode the bubble need to settle out a bit as well.
Or am I an economics ignoramus?
November 19th, 2008 at 2:48 pm
Generally, a multi-year moving average of total inflation tracks well with the core inflation at the center of the time period. There are exceptions. I think is one of them. In a couple of years, we’ll see that core inflation under estimated real inflation for this year and last. I don’t think inflation is going to set oil prices to their historical inflation-adjusted baseline. That would be less than $35 per barrel in today’s dollars. I think we’re looking at a real permanenent increase in the cost of energy. Everything else will go up in price, but not commensurately.
November 19th, 2008 at 4:25 pm
The simple answer as to why deflation is bad is because if a dollar is going to go up in value tomorrow, you’d keep it. On the other hand if it is going to go down in value, you’d invest it, in order to earn a yield that will cover the increase in the cost of living.
This is what happens writ large during deflation. People simply hoard their money, anticipating its increase in value. And then there’s no new investment, no investment capital, no loans, no new businesses, and existing businesses close. Unemployment goes up.
I have found this is mostly an aesthetic issue (although granted, inflation is very bad for people on fixed incomes). People simply don’t like the fact that the value of their money declines. But that’s the cost of having an economy where people invest their money.
November 19th, 2008 at 7:18 pm
Re: Deflation is absolutely coming.
I recall that line back in 2002 also.
So far the only evidence of deflation lies in the fact that gas prices have fallen back to their 2005 levels. That makes up the lion’s share of this headline. Meanwhile I just got back from the grocery store and if deflation is happening there, no one bothered to inform the guys who post the pries on the shelves.
November 19th, 2008 at 8:57 pm
It’s the asset deflation. World stocks have deflated $30 trillion. I am not sure of the latest US real estate number. Pick any huge one you want.
The mother of the asset inflation was credit, the excess thereof, and now credit is shrinking and so the assets prices deflate.
What we have is debt deflation. That deflation means liquidation. There is no particular reason why asset deflation will halt now, or anytime soon. In the early 40’s the DJIA PE ratio was 5. Assuming current earnings are real, which they are not, and sustainable, no way, that would put the S&P at mabye 300. Which is not a prediction but rather a picture of what is possible.
November 19th, 2008 at 11:20 pm
The simple answer as to why deflation is bad is because if a dollar is going to go up in value tomorrow, you’d keep it.
No, because of a little thing we Austrian economists like to call time preference. People will only hoard dollars when they think that the drop in priceis worth putting of consumption. Fairly quickly prices will bottom out and the economy will get back on track.
I have found [distaste with inflation] is mostly an aesthetic issue (although granted, inflation is very bad for people on fixed incomes). People simply don’t like the fact that the value of their money declines.
Except that inflation (i.e. increase in the money supply) is the cause of the unsustainable booms that lead to the deflationary busts.
November 20th, 2008 at 5:26 pm
No, because of a little thing we Austrian economists like to call time preference.
“You Austrian economists” are full of it. In the 19th Century, we had numerous examples of panics caused by asset hoarding due to limited supplies of money. In other words, like with much of Austrian economics, the very thing that you guys swear couldn’t happen, did.
People will only hoard dollars when they think that the drop in priceis worth putting of consumption.
Again, consumption is a straw man. The issue is INVESTMENT. Here’s your choice– you have $1 of wealth. You can keep it, and tomorrow it will be worth $1.01, with the only risk being that the deflation will be reversed (which is not likely because deflation is a positive-feedback loop). Or, you can invest it with the hopes of increasing it to $1.01, but with the risk that you will lose everything. What do you do? That’s right, deflation turns hoarding your cash into a risk-free investment. Thus, ordinary investments, which carry risk, are shunned.
And that means a capital and credit crunch, less business formation and expansion, etc. Consumption isn’t the issue– you are correct that sometimes people want something right now and won’t put it off. But they won’t risk their money in investments if they are better off just hoarding it. And that’s why deflation is so dangerous.
Except that inflation (i.e. increase in the money supply) is the cause of the unsustainable booms that lead to the deflationary busts.
Nope. Business cycles were MUCH WORSE when we had a fixed money supply. MUCH worse. Why? Because having control of the money supply allows our policymakers to do countercyclical monetary policy, which softens recessions and controls booms.
You guys are simply wrong on everything. But you continue to believe it because you are offended by the fact that fiat money isn’t “worth” anything. The fact that it happens to work better than what you advocate is simply not something you care to contemplate.
November 20th, 2008 at 5:49 pm
Nope. Business cycles were MUCH WORSE when we had a fixed money supply.
We never had a fixed money supply, thanks to fractional reserve banking. What we need is a 100% reserve requirement.
November 20th, 2008 at 5:59 pm
Dilan, let me explain further. Business cycles, according to Austrain theory, are caused by the malinvestments that occur when the money supply is artificially increased. This can be done even under a gold standard, by fractional reserve banking. In the 19th century, fractional reserve banking was the main mechanism for business-cycle causing inflation.
Let me explain: If I deposit $100.00 is an account from which I can withdraw from at leisure (as opposed to an account such as a CD where I cannot withdraw for a fixed amount of time), and the bank has a 10% reserve ratio, they can loan out $90.00 of that money. Someone spends it, it gets redeposited. $81.00 of that gets re-loaned out, and the process completes. Eventually the total amount loaned out approaches $1000.00 (shrinking geometric series), all based on only $100.00 of “base” money. By lowering the reserve requirement to, say, 5%, the amount of fiduciary money in the economy can be expanded to $2000.00. The expansion of money based on the fractional reserve causes a boom, with the resulting bust, just as surely as an increase in fiat money would.
The only thing that fiat money does is prevent a run on the banks by allowing the government to print the money to cover all of those deposits of the same money.
I have a feeling, Dilan, that most of hte money hoarding to which you refer was caused ultimately by lack of faith in financial institutions due to bank runs that were aused by fractional reserve-induced inflation. I’ll read up on it more.
March 11th, 2009 at 4:47 am
I bookmarked this site. Thank you for good job!
March 22nd, 2009 at 6:19 am
tramadol
I want to say – thank you for this!
April 2nd, 2009 at 5:26 am
Great site. Good info
buy cheap viagra
April 9th, 2009 at 6:31 am
Very interesting site, Hope it will always be alive! viagra
April 19th, 2009 at 9:55 am
cEYBKh usulkoltawaq, [url=http://pbqkitixixjp.com/]pbqkitixixjp[/url], [link=http://ejepmbuandrj.com/]ejepmbuandrj[/link], http://zviemkigefhr.com/