Paradox of Thrift questions
A friend of mine forwarded this article off to an associate of his who's a Krugman fan. He had a few questions/comments shot back that I hope we could help address. Here are the Krugman guys questions about the Paradox of Thrift article by Mr.North:
"Okay, I think I see a few problems with this article. I think we should take them one at a time.
First:
"Second, hoarding currency pressures sellers to reduce prices. This acts as an incentive for people to buy more goods and services with their currency. The supposed excess of supply then disappears. Holding currency is a means of thrift. This thrift produces a positive result: lower prices and therefore greater purchasing power for the currency. This process was disparaged by Keynes as a liquidity trap. It was no trap. It was a benefit for holders of currency."
1) Sure, deflation is a benefit for holders of currency, but this article says nothing about the effect of deflation on debtors. For instance, companies who borrowed money to build factories based on the profit projections that were made based on pre-deflation prices who find now themselves forced to repay the debt from smaller (deflated) profits and in more valuable dollars.
2) If the total amount of goods is unchanged, then increasing the purchasing power of currency means reducing the amount of currency in circulation, via hoarding. How is this beneficial to the average person? If the hoarders STOP hoarding and put their currency back into circulation, it will trigger inflation (from the deflated price level), and prices will rise back to what they were before the hoarding began (unless there's some overshooting, which is entirely possible). It seems to me that what you IDEALLY want is predictability in the value of the currency. What you want to avoid at all costs is unpredictable changes in the value of your currency (e.g., outbreaks of hoarding).
3) If people hoard cash and thus reduce the amount of currency in circulation, deflation sets in since the supply of goods remains constant. Fewer dollars in circulation, same amount of goods...each dollar buys more goods. Now, people who hoarded cash have increased the value of that cash when they finally choose to spend some fraction of it. Where did that extra value come from? It didn't appear out of thin air, right? To some extent I think this amounts to "cornering the market" on cash, which can't be a good thing, can it? That extra value comes from somewhere, and I think it's transferred from non-hoarders (e.g., people who live paycheck to paycheck, paychecks which are adjusted down to reflect to the lower prices of goods sold).
4) Deflation COULD be a good thing, BUT ONLY if the deflation is caused by a GROWING supply of goods (from productivity gains perhaps) and constant money supply. NOT when caused by constant supply of goods and FALLING money supply (due to hoarding removing currency from circulation). The former raises living standards. The latter just transfers wealth to the hoarders at the expense of non-hoarders."
output
I think those points are
I think those points are gross simplification. "remains constant" is a false asumption in a freemarket system. Only change is constant. It's a dynamic equalibrium. Even currency hoarders have more than one choice of stretching their dolloar - Lower price on consumer goods or higher interest rate investment. Competition works everywhere.
Ok, i'll give it a
Ok, i'll give it a stab:
1.Sure, deflation is a benefit for holders of currency, but this article says nothing about the effect of deflation on debtors. For instance, companies who borrowed money to build factories based on the profit projections that were made based on pre-deflation prices who find now themselves forced to repay the debt from smaller (deflated) profits and in more valuable dollars.
Response: This effect on debtors is the markets way of cleansing itself of misallocated capital aka malinvestments.
2a. If the total amount of goods is unchanged, then increasing the purchasing power of currency means reducing the amount of currency in circulation, via hoarding. How is this beneficial to the average person?
Response:Because the purchasing power of everyone is increased, most especially helpful to the poor and elderly who live on fixed incomes.
2b. It seems to me that what you IDEALLY want is predictability in the value of the currency. What you want to avoid at all costs is unpredictable changes in the value of your currency.
EXACTLY.You nailed it on the head here though:
(unless there's some overshooting, which is entirely possible)
The instability in the value of the money isn't from people saving, it is from the central bank inflating to manipulate interest rates. There isn't going to be stability so long as we have a central bank causing distortions in the marketplace and misallocations of capital. You've got the culprit opposite. It's not the savers who are the problem, but the inflaters.
3a. If people hoard cash and thus reduce the amount of currency in circulation, deflation sets in since the supply of goods remains constant. Fewer dollars in circulation, same amount of goods...each dollar buys more goods. Now, people who hoarded cash have increased the value of that cash when they finally choose to spend some fraction of it.
Response:An increase in purchasing power has occurred for everyone in society, most especially the poor and elderly, who are now able to buy more goods with the fixed income they live off of.
3b.Where did that extra value come from? It didn't appear out of thin air, right?
Response: Correct. That extra value comes from the market cleansing out the distortions which caused the misallocation of capital to begin with.
3c.To some extent I think this amounts to "cornering the market" on cash, which can't be a good thing, can it? That extra value comes from somewhere, and I think it's transferred from non-hoarders.
Response: Correct, cornering the market on cash isn't a good thing. That's why we shouldn't have a private group of individuals with little to no accountability maintaining control over the money supply.
Once again, the opposite of what you are suggesting is the case. The transference of wealth occurs through inflation, not deflation. Those who are first in line (governments, the corporate elite, bomb makers etc) to get the money created by the monopoly that is our central bank have more purchasing power than those who wind up getting the money as it trickles down the pipe into the economy. Those who are last in line (again, typically the poor and elderly along with the middle class) get to use money that is now worth less.
Inflation is a hidden form of taxation and Bernanke, as well as other previous Fed chairman, have openly admitted to it. This is where the transference of wealth is occurring which should be stopped. Deflation is not a hidden form of taxation nor can it be.
4.Deflation COULD be a good thing, BUT ONLY if the deflation is caused by a GROWING supply of goods (from productivity gains perhaps) and constant money supply. NOT when caused by constant supply of goods and FALLING money supply (due to hoarding removing currency from circulation). The former raises living standards. The latter just transfers wealth to the hoarders at the expense of non-hoarders."
Response: Again, the inflation is the sickness and deflation/saving is the cure to wipe out the misallocation of capital that came through the inflation. The deflationary process is the cure, not the disease. If we had a stable monetary system based off something like Gold or Silver there would be much less deflation occurring due to misallocation of capital because there wouldn't be as much distortion in the market place to begin with. The *good* deflation of which you speak would be pretty much the norm as it was for most of the 19th century. This is most beneficial to the poor/elderly and provides them with purchasing power for the small savings they accrue throughout their lives. They can know for sure that the dollar they put in their mattress when they are 20 is going to be able to buy the same or very nearly the same amount of good/service when they are 50.
F.A.Hayek won a Nobel prize pertaining to this concept and it just makes much more sense to me than saying everyone should spend, spend, spend even if they are bankrupt or close to it. That just doesn't seem like a very good idea for individuals nor for governments.