Question: Why is deflation so bad? I have certainly benefited from the drop in gas prices, so I wonder what is wrong with things becoming cheaper in general? And wouldn’t that make up for previous inflation?
Paul Solman: Another good question. Like inflation, a little DEflation isn’t necessarily a bad thing. But a lot of either is, because they feed on themselves.
Gas price deflation by itself is no problem, except, perhaps, for the owners of gas. And as you suggest, they had it great for years.
But what about when clothing prices go down? And car prices? And kayak prices? And art prices?
Yes, everything becomes more affordable. But what about the people who make and sell the clothes and cars and kayaks and art? How do they pay their employees? OK, you might say, they can cut pay by the amount the prices go down and everyone will stay even.
But what about the loans they’ve taken out to finance their raw materials? Who’s going to renegotiate those loans down? Companies are stuck paying higher rates of interest (because banks are scared) and yet the dollar is deflating: gaining value. So businesses wind up owing more. Yet they have lower revenues.
So, they lay off workers. The workers have less money to spend and are more afraid than ever. They stop spending. Businesses have to lower their prices even further, stoking the downward spiral.