Prices fall in a scenario where the currency is not inflated and, therefore, there are more sustainable investments and increased productivity. In an economy with little or no government intervention, there are more long-term investments, which increase the economy’s productivity. In a deflationary economy, the purchasing power of money tends to increase, as there is no monetary inflation by central banks and prices tend to fall. Consumers can purchase more products and services and companies have higher profit margins.
But governments do not like deflation, they are the most indebted entities.
«Deflation Will Cost Entrepreneurs»
In addition, the prices of the inputs used in production will also fall in a deflationary economy. Because prices got lower, consumers began to buy more, which increased the industry's profits, which brought more investments and higher productivity.
«Consumers Will Postpone Consumption under Deflation»
The reasoning behind this argument is that if prices are constantly falling, no one will buy the products and services because individuals will always expect prices to go down. This also does not make sense, as there are always products and services that people have to purchase. Only when the product or service is expensive do consumers postpone consumption, which is what occurs with constant inflation created by central banks. A deflationary economy makes industries more profitable and more efficient.
The Economy Becomes Less Indebted
In a deflationary economy, consumers would tend to buy products and services in cash rather than by going into debt. The incentive to save would be higher, which would lead to more investments, which would lead to greater productivity, which would lead to cheaper and better products and services, which would lead to higher profits, which would lead to more incentives for investments. It’s a beneficial cycle for the economy. Furthermore, the current scenario of zombie companies would not occur in a deflationary economy, as the incentive would be for savings and investments in productivity, not indebtedness.
Historical Examples of Deflation
An example of deflation occurred in the US in the nineteenth century. «Despite» this deflation, the nineteenth century was marked by great economic growth in the US. This is precisely what happens in a deflationary economy. From 1815 to 1914, the US was in a gold standard, which is deflationary.
There were only a few inflationary periods, such as the Civil War in the 1860s. As of 1981, the MAS, Singapore's central bank, began to interfere only in the exchange rate, controlling the value of the Singapore dollar in relation to a basket composed by the currencies of the main economies of the world, increasing and reducing the monetary base through purchases and sales of assets, respectively. The goal is to have a currency that continuously appreciates against the others. The result was that between 1982 and 2005 the SGD was the currency that lost less purchasing power in the world, surpassing even the Swiss Franc.
Hence, the inflation rate remained low. At some points, there was even deflation. When it became independent from Malaysia in 1965, Singapore adopted high economic freedom, which led to the surging of private companies that were very competitive in the global market, and to a high standard of living. The government adopted a policy of low public spending and low taxation, almost nonexistent bureaucracy, and few regulations.
The less inflationary policy of the MAS is one of the main factors that contributed to Singapore's performance.
Source: Andre Marques | Mises Institute
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