Mon, 22 Jan 2007

Deflation

UPDATE: followup at Deflation 2.

I keep seeing this fear of deflation everywhere. I don't know where it comes from. Deflation is the natural consequence of free trade with a fixed amount of currency. Consider this: If you have eggs to sell, and want to buy plums, let's sake that you'll take an even trade. A dozen plums for a dozen eggs. Of course, you want the plums more than the eggs, so once you get the dozen plums, you would only be willing to give up 11 plums to get back the dozen eggs.

Now imagine that your country uses plums as money. You're willing to pay 12 plums for a dozen eggs. You like those plums, so you'll only pay 11 for the dozen eggs. The plums are the same, and so are the eggs. What's the difference? Why have the plums deflated? The answer is that the trade has pleased you. You are wealthier, so you value your money more.

As long as the number of plums is fixed, this process will go on forever. Plums will become more and more valuable, as each trade makes people more content. If you see deflation as a reflection of increasing contentment, then you, like me, will wonder why people don't like deflation.

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