I was an economics major and never understood the main stream view of economists on that (that it's bad).
Think of it this way: the real interest rate is the nominal interest rate minus the inflation rate. That means that if the inflation rate is negative, people can effectively earn interest simply by sitting on their cash, since it'll be worth more in the future. If people earn interest by doing nothing, what incentive do they have to invest in a potentially risky venture that may make more in the long run, but may also cost them their principal?
Deflation biases people towards inaction, because they know that sitting and waiting means their money will be worth more in the future. Inflation biases people towards action - they know their money will be worth less in the future, so they may as well invest in something. The Austrian critiques of monetary inflation are basically right - it does result in bubbles, as people seek higher returns from progressively more risky investments because they know their cash will be worth less.
Technically, the mainstream economist view shoots for price stability (0% inflation) and not inflation. But they recognize that they'll never achieve that, so they err on the side of inflation. Mostly, this is because inflation is easier to cure than deflation is. If everybody is biased toward inaction, then when the Fed pumps money into the system to stimulate action, it tends to collect within firms who won't spend it because they expect it'll be worth more in the future. (This is currently a very real problem, as much of the money the Fed injected in 2009 is collecting in banks that are trying to shore up their balance sheets and consumers that are trying to pay down debt.) Each firm always has the option of choosing not to spend the money it's received. All it takes is one firm that wants to hoard, and the money will never circulate within the economy.
If you have continuous low-level inflation, however, it can be brought under control simply by reducing the money supply. You can't spend money that you don't have. (Well, you can on a micro-level by borrowing from another firm, but you can't on a macro-level because there's nobody else to borrow from.) So when the Fed restricts the money supply, that reduction filters all the way through the economy, people have less money to spend, and prices drop.
Kind of like the incentive people have when evaluating electronics, which are under consistent, massive deflation thanks to technological progress? Not such a problem there, is it? We're not fussing over Dell or Apple, or the car companies, for that matter, who see similar, though less pronounced, levels of technology-driven deflation.
Why would such a force, which is so innocuous in these areas, and which develops naturally due to the rise in productive capacity & efficiency over time, be so problematic macroscopically? Why would people stop investing, any more than stop buying computers and cars now? Before answering, see my following point.
> what incentive do they have to invest in a potentially risky venture that may make more in the long run, but may also cost them their principal?
An incentive driven by seeking greater return. In your world, wouldn't everyone invest in the bond market, or buy annuities, rather than the riskier stock market? Doesn't exactly gel with reality, does it?
> If you have continuous low-level inflation, however, it can be brought under control simply by reducing the money supply.
What does lowering the money supply do, pray tell? Wouldn't that increase the value of the dollars remaining in the system? That's deflation, by definition. How can it be both your solution and your problem?
> Deflation biases people towards inaction, Inflation biases people towards action
We'll speak more clearly if we aren't so broadly. Natural deflation is not static, but a force dynamically determined by facts of the economy, such as the growth in productive output.
For natural deflation, little investment -> less growth in productive output -> little deflation -> more incentive to invest. Likewise for the converse: lots of investment -> more deflation -> less incentive to invest. This dynamic interplay is a self-regulating force which serves to naturally counteract the market propensity to go off the rails on some wasteful bubble or other.
Seems to me your arguments are specious, and the current bias against deflation is an orthodoxy.
People put off electronics purchases all the time because of price deflation. How many times have you heard people wait until the next Macworld before buying things from Apple, or wait and see what the next Android phone will be before buying anything?
It's not really a problem for the electronics industry because electronics is a robust and growing industry anyway. So people spend less than they otherwise would, but nobody cares because they're still spending more (on electronics) than they used to.
That growth is because electronics is a substitute for several other old economy goods. What's good for the iPad and the Kindle certainly isn't good for the publishing industry. It is good for the consumer and the economy, because it encourages people to switch away from more resource/labor-intensive, less useful goods like books, and towards less resource/labor-intensive, more useful goods like tablet PCs.
You can't apply the same logic to the level of the whole economy, because (by definition) there's nothing for the consumer to switch to. Price deflation across the whole economy means that the consumer is encouraged to switch away from goods and into cash. But cash itself is non-productive; it has no utility for anyone beyond a means of purchasing other, more productive goods.
Whenever you get confused about macro/micro effects, it's helpful to forget money entirely and look at what people actually do. When prices drop for computers, people switch away from other goods and buy more computers, which, assuming computers are more efficient to manufacture, is good for the economy. When prices drop across the economy, there's nothing for people to switch to, except cash, and cash is not good for the economy or the consumer.
> An incentive driven by seeking greater return. In your world, wouldn't everyone invest in the bond market, or buy annuities, rather than the riskier stock market? Doesn't exactly gel with reality, does it?
"My world" doesn't actually care whether people purchase bonds or stocks or real estate. It abstracts those away and assumes the relative asset mix and risk preferences will be the same. The only difference is that the rate of return for holding cash has gone up, and hence some percentage of the people who otherwise would've purchased stocks or bonds or real estate will instead hold cash. Because they now hold cash instead of stocks/bonds/real estate, they have no incentive to improve ("invest in") the businesses represented by those stocks or bonds.
> What does lowering the money supply do, pray tell? Wouldn't that increase the value of the dollars remaining in the system? That's deflation, by definition. How can it be both your solution and your problem?
No. That's a decrease in the money supply, by definition. (Some people define inflation as a change in the money supply, but such definitions are highly unorthodox, and can't describe phenomena like the 2008 deflation, where the money supply increased sharply yet prices fell.)
Over time, as people's expectations adjust, a rise in the money supply will tend to lead to inflation and a fall will lead to deflation. But before you get full-blown deflation, you're going to get disinflation, where prices are still inflating but at a slower rate. That was the situation during Volcker's "shock therapy" in the 1981-82 recession: the money supply contracted, the contraction squeezed the inflation rate down to something manageable, but then the contraction was reversed before prices could actually start falling.
> We'll speak more clearly if we aren't so broadly. Natural deflation is not static, but a force dynamically determined by facts of the economy, such as the growth in productive output.
Agreed.
> For natural deflation, little investment -> less growth in productive output -> little deflation -> more incentive to invest. Likewise for the converse: lots of investment -> more deflation -> less incentive to invest. This dynamic interplay is a self-regulating force which serves to naturally counteract the market propensity to go off the rails on some wasteful bubble or other.
Somewhat agreed. This, empirically, seems to be the case when deflation is minor and the economy is hovering near equilibrium.
It does not appear to be the case when there is a sudden shock to the system. For example, a financial panic increases the demand for hard currency, which pushes up the value of currency (deflation), which encourages people to hoard even more currency, which causes still more deflation. In theory, this should be self-limiting when entrepreneurs realize that assets are available for bargain-basement prices, then buy them (without credit, otherwise they're at the mercy of fickle creditors) to put to use in new industries. In practice, there's good evidence that it can last a decade or more. It only takes one bad 4-year term to unseat a modern democracy, so policymakers have a strong incentive to not let things get so bad for so long.
On a micro level, if your wages are deflating and your costs are not, it's bad. If the prices of goods/services required to run your business are deflating and the prices you are able to charge are not, it's good.
On a macro level, good deflation is the result of gains in productivity (e.g. improved technology). Bad deflation is when capital assets are reduced in value.
N.B. This is just my preferred, non-scientific view of the matter, but it seems to apply consistently within most discussions of this topic.
Regarding the OP's question, measure twice before mentioning an idea to someone who is your current equity partner in a start-up. You may be legally bound to share the idea and any work contributed to it, unless otherwise specified in your agreement.
