C
Cardano
Member
Yetanotherstudent,
It's not really surprising that you don't know that much about deflationary environment. There hasn't been one for 70 years, it's not really taught in economics degrees except as a cursory aside, CT7, while not entirely useless, is clearly indequate for actuarial training. I suspect about 1 in 100 on the forum has any real idea about the effects of deflation, and probably only 1 in 50 qualified actuaries.
There are basically two types of deflation. The first is benign and caused by productivity increasing faster than the money supply. The second is malign and caused by paring down of debt by a liquidation process.
The USA in the 1920's was a very good example of the first benign type of deflation, where the money supply expanded (alarmingly at some points) but prices kept falling as productivity more than kept pace. The same would have happened over the last 10-15 years had Western Governments not deliberately set positive inflation targets and ramped up the broad money supply to achieve them. Essentially the deflation in far eastern imported goods was more than offset by service sector inflation.
The problem with era's of benign deflation is that central banks do not have to keep ramping up short term interest rates to control inflation when the money supply is expanding rapidly. The rapid increase in money supply leads to large increases in indebtedness and these are the conditions that lead to malign deflation. In the 1920's the sum of personal, corporate and government debt in the US went from about 100% to 300% of GDP. The same has broadly happened over the period 1982-2007 going from 100% to 275% in the 1980's and up to about 325% now. Clearly a debt liquidation is long overdue.
The problem with malign deflation is that everyone pares down there debt either by default or by paying it back. If default occurs then the bank's capital falls (does this sound familiar) and they need to withdraw a much larger amount of lending due to the money multiplier effect. Thus corporate lending falls and thus with less investment there are less jobs. When people pay back debt instead of buying consumables then employment in manufacturing falls, with consequent knock on effects elsewhere.
The effect of paying back debt or default of debt is to collapse the money supply and thus the general level of prices fall. The real value of debts also increases making them a larger burden on those holding them. This increases the level of defaults and the desire to pay them back. This is essentially a positive feedback process which is known as a deflationary spiral.
Deflation ends when debt levels reach a sustainable much lower level. The end is usually marked by what I call "what the heck prices". For instance if at the end of this I can buy a three bedroomed house in a reasonable part of London for say 65000, then I'm going to say "what the heck if I lose another 15000, I've still got a house" Also the level of leverage at the end of a debt liquidation is very much lower than at the top and so you get very few forced sellers and thus a large supply no longer hangs over the market.
It's not really surprising that you don't know that much about deflationary environment. There hasn't been one for 70 years, it's not really taught in economics degrees except as a cursory aside, CT7, while not entirely useless, is clearly indequate for actuarial training. I suspect about 1 in 100 on the forum has any real idea about the effects of deflation, and probably only 1 in 50 qualified actuaries.
There are basically two types of deflation. The first is benign and caused by productivity increasing faster than the money supply. The second is malign and caused by paring down of debt by a liquidation process.
The USA in the 1920's was a very good example of the first benign type of deflation, where the money supply expanded (alarmingly at some points) but prices kept falling as productivity more than kept pace. The same would have happened over the last 10-15 years had Western Governments not deliberately set positive inflation targets and ramped up the broad money supply to achieve them. Essentially the deflation in far eastern imported goods was more than offset by service sector inflation.
The problem with era's of benign deflation is that central banks do not have to keep ramping up short term interest rates to control inflation when the money supply is expanding rapidly. The rapid increase in money supply leads to large increases in indebtedness and these are the conditions that lead to malign deflation. In the 1920's the sum of personal, corporate and government debt in the US went from about 100% to 300% of GDP. The same has broadly happened over the period 1982-2007 going from 100% to 275% in the 1980's and up to about 325% now. Clearly a debt liquidation is long overdue.
The problem with malign deflation is that everyone pares down there debt either by default or by paying it back. If default occurs then the bank's capital falls (does this sound familiar) and they need to withdraw a much larger amount of lending due to the money multiplier effect. Thus corporate lending falls and thus with less investment there are less jobs. When people pay back debt instead of buying consumables then employment in manufacturing falls, with consequent knock on effects elsewhere.
The effect of paying back debt or default of debt is to collapse the money supply and thus the general level of prices fall. The real value of debts also increases making them a larger burden on those holding them. This increases the level of defaults and the desire to pay them back. This is essentially a positive feedback process which is known as a deflationary spiral.
Deflation ends when debt levels reach a sustainable much lower level. The end is usually marked by what I call "what the heck prices". For instance if at the end of this I can buy a three bedroomed house in a reasonable part of London for say 65000, then I'm going to say "what the heck if I lose another 15000, I've still got a house" Also the level of leverage at the end of a debt liquidation is very much lower than at the top and so you get very few forced sellers and thus a large supply no longer hangs over the market.
