Rafi Mohammed

Why is Deflation a Bad Thing?

Posted on December 1st, 2008 (0 Comments)

The other day I stopped by my local gas station and was greeted by a glorious sight…gas for $1.92 a gallon. Halleluiah, $20 in the tank is actually meaningful again.

Remember last summer when gas crossed the $4 mark? Everyone was uptight about inflation. Since oil is such a crucial input factor, economists worried that prices would spiral upward and our economy would suffer from the negative effects of inflation. Now, with gas prices dropping like a rock, everyone is worried about deflation. Geez, can’t our economy get a break? First we are worried that prices are spiraling upwards and then 4 months later, we are fretting about the exact opposite.

I decided to research deflation and here’s what I discovered: it’s not as bad as many think.

Tell me, how can gas prices dividing in half be a bad thing? Actually, it’s good. What about telecom prices dropping due to competition? Are $99 television, phone, and Internet bundles (normal price: $150) bad for the economy? Of course not…our government promotes healthy competition to reduce prices for consumers. Is the fact that in 4 months, the laptop we buy today will be replaced by a cheaper, more powerful model. Doesn’t sound all that bad to me. In fact, all of these price decreases are good for the economy. Oh, and with lower prices, we can afford to purchase more products on our current salaries. That’s pretty good, don’t you think?

That said, there are cases when deflation is bad for our economy. First, if deflation is a symptom of a faltering economy. If firms get desperate and slash prices to survive, profits go down and layoffs ensue. Next stop: recession. Second, if deflation becomes so expected that firms and consumers hold off purchasing today because they believe prices will decrease tomorrow. If we get caught in this spiral, it becomes a self-fulfilling prophecy. Purchases are put on hold, companies discount in desperation, consumers continue to wait…and well, you get the picture…it’s disastrous for our economy.

It’s hard for me to believe that this second scenario is realistic today. That said, and I’m trying not to cite stories that are in my upcoming book, but this statistic is so good that I have to. A Wall Street Journal source claims that only 53% of the 20,000 condominiums built since 2003 in Miami have been sold. This glut of condos combined with frantic sellers has created a deflationary spiral. Why buy today when chances are that prices will be lower tomorrow.

The bottom line: not every type of deflation is bad. The deflation we are currently experiencing is good for our economy. So enjoy the low gas prices…go for a long drive. And if stores are going to duke it out via discounts…take home the “wish list” product that you’ve been eyeing for the last several months.

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