why deflation would be a disaster

Why deflation would be a disaster for this country if it took hold

08 April 2014

ECB President Mario Draghi said recently that when the prices of goods fall, people buy more of those things. That is, unless people expect prices to fall further..

..There are real fears we will see deflation across the eurozone. Consumer prices are now falling in Cyprus, Greece and now Spain, and are near zero in almost every other country, including Ireland, where the year-on-year change was -0.1pc last month.

You might think 'yes, yes! cheaper stuff!', and you'd be right to think that way, at least at first. As ECB President Mario Draghi said recently, when the price of things falls, people buy more of those things. That is, unless people expect prices to fall further.

Once people expect prices to fall further, then they don't purchase goods, services and large durables like cars and appliances right now, which leads to lower cash flows and profits for firms, who have to fire people or not take anybody else on, and this leads to higher than expected levels of unemployment, which leads to lower spending on goods and services, an increase in inventories across the board, which causes further decreases in prices as firms put their goods on sale.

General falls in the price level don't just affect apples, they affect property prices and, crucially for Ireland, debt and debt repayment levels, because just as inflation carries an implicit transfer from lenders to borrowers, so deflation carries the reverse transfer: borrowers are paying back more than they borrowed.

In an economy like Ireland, the ratio of household debt to disposable income is about 196pc, while the UK's debt to disposable income is about 140pc, and in the US it is about 120pc. Any large negative change to Ireland's general price level might have a catastrophic effect on our housing markets, but also on economic growth and the repayment of our debts..

Read the complete article here; http://www.independent.ie/opinion/columnists/stephen-kinsella/why-deflation-would-be-a-disaster-for-this-country-if-it-took-hold-30164212.html


With the ratio of household debt to disposable income in Australia now at a record high, deflation would be a disaster for this country too. Unfortunately, this once seemingly impossible scenario is becoming increasingly likely, not only throughout Europe, Japan, the U.S. and China but even here in Australia.

That’s simply because debts that can’t be repaid won’t be repaid. Such debt deflation (default, restructure and deleveraging), coupled with a contraction in credit growth due to waning demand, results in a deflationary spiral that central bankers dread. That’s because, as Japan has shown for more than two decades, once deflation takes hold there is little that the ‘powers-that-be’ can do to stem the spiral down in asset values and the subsequent financial and banking crises nor the economic malaise which follows.