Readers Question: Why do most people prefer inflation to deflation? is it because such guys are business owners and they don’t to earn a little or what ? what about poor people. how can they make ends meet? think properly, think widely, think about the poor first. then I am sure, you are going to change your mind.
The biggest cause of poverty in developed economies is unemployment. The real problem of deflation (or even very low inflation ) is that it creates an economic situation where unemployment tends to increase.
Inflation tends to hit not the poorest in society, but, the middle classes with savings. If you have cash savings, high inflation can destroy your wealth. The poorest often have little savings and are so not affected by inflation. (indeed the poorest may have debts which get wiped out by inflation) Also, this point is largely academic in the post-war period. As we have never really had a period of hyperinflation where real interest rates were negative.
- An inflation rate, of say 5%, doesn’t necessarily make people worse off –
- If Real interest rates are positive – savings don’t devalue. if we have nominal interest rates of 6 or 7% and inflation of 5% bank savings will increase in real value.
- If Real Wages are positive. – If nominal wages increase faster than inflation, real wages rise.
- Most benefits are index linked. Therefore a rise in inflation rate will lead to higher benefits for those who are out of work.
Therefore, a moderately higher inflation rate doesn’t necessarily increase poverty.
Why Does Deflation Cause Poverty?
- Deflation tends to reduce aggregate demand and economic activity.
- If people expect prices to fall, people delay consumption and investment leading to lower output, and higher unemployment.
- Deflation increases the real value of debts. This reduces living standards of those saddled with debts delaying growth and expansion.
- In periods of deflation, nominal wages tend to be sticky downwards causing real wage unemployment.
- The worst period for poverty in the UK was not periods of high inflation (like the 1970s and late 80s). The worst periods were the 1920s and 1930s. Deflation in the 1920s was a major factor in causing mass unemployment and prolonging the great depression.
- At all costs, we want to avoid deflation. Yet, there are many Central Banks around the world – especially the ECB, who seem to be unconcerned about the prospect of disinflation / deflation and the economic costs it will create.