I have mentioned before that I believe that we are entering into a deflationary environment.
As credit continues to tighten at lending institutions, eventually a more damaging economic consequence will occur -- a decline in the desirability for consumers to take on debt. This severely curtails the ability to manage (i.e. expand) money supply.
It is the only potential flaw in the logic of monetary policy. The foundation of our monetary policy is idea that there is an infinite demand for money. By adjusting interest rates, policymakers can control the marginal demand for money -- that is the propensity for people to take out loans.
But what occurs when having debt becomes socially unacceptable? Or when people decide to not take on additional debt due to fears of the economy, or an inability to make debt service payments going forward? What if people are less likely to take on debt because of the things around them they see -- debt laden friends and parents declaring bankruptcy? In such a case, lowering rates to zero has no effect.
So a deflationary environment would come from a decrease in lending despite a decrease in the lowering of interest rates.
Isn't that what we are seeing? Those who are certain that inflation will occur due to the lower interest rates, fiscal stimulus spending, or the Fed's balance sheet are missing the rest of the story.
What is the result of deflation? Lower prices, decreased economic activity, dropping corporate revenues, and dramatically lower profits. The velocity of money dramatically slows, as people decide to hold on to their money rather than spend it.
Sounds familiar to what is going on right now.
As credit continues to tighten at lending institutions, eventually a more damaging economic consequence will occur -- a decline in the desirability for consumers to take on debt. This severely curtails the ability to manage (i.e. expand) money supply.
It is the only potential flaw in the logic of monetary policy. The foundation of our monetary policy is idea that there is an infinite demand for money. By adjusting interest rates, policymakers can control the marginal demand for money -- that is the propensity for people to take out loans.
But what occurs when having debt becomes socially unacceptable? Or when people decide to not take on additional debt due to fears of the economy, or an inability to make debt service payments going forward? What if people are less likely to take on debt because of the things around them they see -- debt laden friends and parents declaring bankruptcy? In such a case, lowering rates to zero has no effect.
So a deflationary environment would come from a decrease in lending despite a decrease in the lowering of interest rates.
Isn't that what we are seeing? Those who are certain that inflation will occur due to the lower interest rates, fiscal stimulus spending, or the Fed's balance sheet are missing the rest of the story.
What is the result of deflation? Lower prices, decreased economic activity, dropping corporate revenues, and dramatically lower profits. The velocity of money dramatically slows, as people decide to hold on to their money rather than spend it.
Sounds familiar to what is going on right now.
