Deflationary spirals
A deflationary spiral is the idea that once (price) deflation begins, a self-reinforcing feedback loop ensues, which results in cessation of most trade, unless the central bank intervenes by printing money/spending.
- factors which counter a deflationary spiral
- entrepreneurs decreasing production in response to falling prices, therefore reducing supply.
- consumers demanding a higher qty of goods, as a result of the lower prices. I.e. as prices decrease, qty demanded increases.
- Deflationary spiral is in essence a speculative bubble without which does not end, in the context of a currency
- Such indefinite speculative bubbles are not know to occur in any other assets, e.g. shares.
- So same arguments for why share price bubbles eventually reverse/end can be used to argue that deflationary spirals will also end. Namely that investors eventually decide that:
- appreciation will not continue, so they allocate some of their portfolio away from the share towards other assets, therefore reducing demand.
- appreciation will continue but they prefer present goods now to a greater qty of future goods, due to their time preference being “higher” than the expected share appreciation rate.
- So same arguments for why share price bubbles eventually reverse/end can be used to argue that deflationary spirals will also end. Namely that investors eventually decide that:
- generally currencies are also less volatile than share prices, so a speculative bubble for a currency should result in lower volatility for a currency than it usually causes for share prices.
- Such indefinite speculative bubbles are not know to occur in any other assets, e.g. shares.
- If deflationary spirals turn out to be a problem, people would adopt forms of money without this volatility risk, voluntarily. E.g.:
- free banking/fractional reserve banking bank notes
- (free banking proponents argue that fractional reserve/free banking addresses these problems but I forget the arguments)
- cryptocurrencies/stablecoins with mechanisms for minimising volatility
- free banking/fractional reserve banking bank notes
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