Deflation is better than its reputation

ECONOMIC theory tells us that deflation is bad. Rising real value of debt soaks money out of the system instead of boosting consumption or investment. That may be correct as a partial analysis, but a general analysis is more complex and does not warrant such hasty judgement.

With unchanged or rising nominal wages, deflation hikes the real purchasing power of income, which in principle should encourage households to consume. Figures from the US, Japan, and the eurozone do not give a uniform picture as these players' economic policies diverge instead of converge. US real wages have recently been in the doldrums with a marginal increase over 2014; figures for the last couple of months of 2014 were good, nourishing expectations of rising real wages in 2015. Real wages in the eurozone rose over 2014 auguring higher purchasing power. Real wages are falling in Japan with 2014 posting the 17th straight year-on-year drop.

Households have debt, much of it in the form of mortgages, which are inflated in real value when prices fall, but this "fact" does not automatically lead to reining in consumption as a "behavioural" change. Consumer behaviour is guided by the perception of future real burden of borrowings compared to the real value of the property as these two figures define property's future real wealth. The presumption is that higher real value stimulates consumption; lower real value depress consumption. Analysing the current picture, it is not at all clear why households should expect future real wealth to fall.