Friday, December 19, 2008

Falling Prices (1) - Postponed Spending

Asset prices and commodity prices are falling rapidly as the impact of the global credit crunch permeates the world economy. Newspaper columnists are now starting to warn of the dangers of deflation. The first concern is that consumers defer their spending when prices fall.

Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop (Ambrose Evans Pritchard Daily Telegraph).
It encourages people to defer spending, as they wait for prices to fall further. This in turn forces down the price – as retailers slash prices in a vain attempt to attract shoppers. As retailers cut prices, so too do manufacturers, who then have less money to invest in new technology, equipment and, crucially, staff.

Wages then start to fall – psychologically very damaging for consumers, even those that keep their jobs. As they fret about less money in their pockets and their job prospects, they further postpone spending, starting the deflationary spiral once again (Harry Wallop, Daily Telegraph).
These statements are nonsense. Falling prices do not stop consumer spending. Computer prices have been falling for the last twenty years, but spending on computers never stopped. Although prices of most consumer electronics have fallen dramatically over the last decade, sales have increased significantly. The reason is that when prices of things fall, more people can afford to buy them, so sales increase.

The benefit of falling prices is that consumers can buy things when it suits them. During inflation, people rush into purchases before they can afford them, because they are scared that the price will go up. They will often get into debt, trying to beat rising prices. Inflation forces people to make purchases at the wrong time.

Falling prices eliminate this problem. People are not put under unnecessary pressure to buy. They can save for something they need knowing that price increases will not push it beyond their reach. People are free to buy large items when the time is right for them. Falling prices increase freedom.

The related benefit of falling prices is that people get access to better quality goods. By waiting a little longer, they can get a later model, at the same price. This makes them better off.

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