A question for all you economic majors...

[propita]

Reports again that we could all be headed for a "double dip" or a "second recession" and/or "deflation."

So what would we see if there was deflation? If someone had money in the bank, what would happen to it? If someone kept some cash at home (a few thousand), what would that mean for them?

I'm assuming that someone with little or no money saved anywhere would be screwed, as usual. But anything even worse? If they still were working and made some money, would that be enough to pay the rent, buy food, etc? Would prices fall or rise?

And what of all those contracts that have huge fees if cancelled early? If millions could no longer afford cell phones, would they still seek to collect--or would that just cost too much and they'd write it off?

 

[Robert Maxwell]

I am not an economics major but I did consider it, and studying economics is one of my hobbies, so here I go...

Deflation means your money is worth more now than it used to be. It's the opposite of inflation. If you have $1000 in the bank, it stays $1000 under deflation, but it has more purchasing power. In real terms, deflation means prices are falling. We had a bout of deflation when this recession started.

Deflation is good for savers and bad for debtors. It's good for imports (it makes them cheaper) but bad for exports (it makes them more expensive for foreign markets.)

Someone on a low income would benefit from deflation, assuming they managed to keep their job!

As for cell phones, a broken contract results in a termination fee, as you said. The carriers would still try to collect. If the carrier is unable to collect anything within a certain time frame (usually either 90 or 180 days), the debt is charged off to a third party collection agency. This is a very bad mark on your credit. The third party will continue to attempt to collect on the debt, but since most contract termination fees are $100-200, it's typically not worth the effort to seek a wage attachment (garnishment.) Depends on whether or not you racked up a huge bill along with it. $1000 is worth the trouble to garnish; $100 rarely is.

In any case, a debt that doesn't get collected usually is written off for tax purposes, but I believe you can only write off a portion of it, not the entire amount.

 

[Pegaritaville]

Okay, I have a BS in agricultural economics and a masters in applied economics, but I'm still not sure how to answer.

First of all, recession and defaltion don't always (or even usually) go together. You can have "good" deflation (such as when technological advances drive down costs) or "bad" deflation (an oversupply of goods and services and so little demand that the market can't correct for the glut).

Deflation worries seem to be a hot topic right now. Deflation is a scary scenario- even more so than inflation, there's the potential to get into a spiral that's difficult to get out of. If people believe their money will be worth more in the future, it's awfully tough to induce them to spend or invest it now.

I don't see that happening, though. Sure, a lot of western economies are in a funk, but globally, there's still a lot of demand. The economies of China, India, Brazil and numerous other countries are still going strong.

As far as going into a "double dip" recession: Yeah, I expect that. Too much of the so-called recovery was government driven (I'm not saying it wasn't money well spent, but there's only so much governments can do). And things may never return to "normal". I see a reshuffling of assests- both nationally and internationally. With any economic upheaval, there will be winners and losers.

By the way, I wouldn't worry about the cell phone companies: They may have to eat quite a few bucks from cancelled services, but they've almost become an essential service and in that sense have a fairly inelastic supply curve.

 

[Botany Bay]

Great answers guys. Good to be amongst the econ-nerds

Deflation, as well explained above, is about as bad as it gets, and the reason that the central bank's printing presses will continue to crank out fresh dollar bills to avoid any chance of the "D" word taking hold of people's behaviour.

Falling prices help the spending power of your savings, but will make paying off your debts a lot harder as their real value rises.

I don't have a psychic octopus, but I think the odds of a double dip are decreasing by the day. You see the media often confusing sluggish growth with a return to recession, which isn't much help for sentiment.

The markets are having a nice run this week. Let's hope it continues.

 

[Robert Maxwell]

I just realized no one here threw out the traditional definition of what a "recession" is, so I will.

A recession is considered to have occurred when you have at least 2 consecutive quarters of GDP (gross domestic product, basically the sum total of all economic production) contraction, meaning the economy is actually shrinking. Our GDP growth rate is 2.7% (per year) right now.

GDP growth doesn't necessarily have to line up with employment numbers, since productivity is a huge factor. You can have a growing economy with high unemployment just based on productivity gains, which are driven primarily by technological advancements. However, when times are good, companies compete against each other to expand more quickly, and this leads to hiring. We are just not in that part of the cycle right now--most companies are still too skittish to go on hiring sprees.

 

[Holdfast]

The markets are having a nice run this week. Let's hope it continues.

Amen to that.



My call is that the odds of a double-dip are pretty low. Earnings growth looks solid and even if there's a small retail slowdown caused by skittish consumers, we're seeing enough growth elsewhere in the world to compensate. The odds are marginally higher in the UK & Europe compared to the USA, due to the need to trim public expenditure and raise taxes, due to our ballooning deficits, but even here I don't think we'll double-dip.

I also don't think deflation is particularly likely either. But to see what effect it has on an advanced economy doesn't require any major stretch of the imagination. Just take a look at Japan over the past couple of decades. Stagnant growth, anaemic consumer demand and a currency/export-dependent economy easily buffeted by global headwinds. Deflation results in falling prices leading consumers to postpone purchases in the hope of future further discounts. It's a terrible thing for an economy as it basically grinds GDP to a halt as there's no incentive to spend on anything, leading to economic stagnation.