Saturday, January 17, 2015

Income Disparity and Deflation

As previously discussed, a natural byproduct of the increased cost to start and run a business is rising income disparity (see Income Disparity Simplified).  With more and more of a country's income being concentrated in a smaller and smaller segment of its population, another problem will arise, that being the prospect of deflation.

On an overall basis, a country's general price level can be viewed as the point where its "supply" and "demand" curves intersect, with the "supply" curve reflecting all of the goods and services that are available and the "demand" curve generally reflecting the cumulative pool of money available to purchase those goods and services.  Productivity gains shift the supply curve upwards and, without a corresponding increase in the money supply, result in lower prices.  Correspondingly, increases in the money supply without an increase in productivity will result in higher prices.  If both productivity and the money supply grow at the same rate the price level would theoretically stay the same.  What usually happens, however, is that the money supply rises somewhat faster than productivity, with the difference accounted for as inflation.

Note that I used the term generally above when defining the demand curve as reflecting the cumulative amount of money available.  The reason I used that term is that historically the money in the economy has turned over at a relatively constant velocity.  If velocity is steady, then central banks, like the Fed, can manipulate the price level simply by raising or lowering the money supply.  That's what Quantitative Easing (QE) was all about.  By increasing the money supply, the Fed was trying to raise the country's demand curve in hopes that the price increases that should have happened would attract business owners to raise production, hiring,...etc.  The problem with their theory was that velocity has collapsed.  The question is, why?

Everywhere you read these days, economists bemoan the low inflation rate and fear deflation.  We've all seen the decline in oil prices, but is there anything else in our daily lives where the price has fallen, or even stayed the same?  The prices of food, rent, healthcare and  tuition, all major expenses for a middle or lower-income family, seem to constantly rise.  The question shouldn't be "where is there inflation?".  It should be "where isn't there inflation?".  And if that's the case, why all the fuss about deflation.

The problem is that nested inside an overall slow, potentially deflationary, environment is an inflationary subset of pretty much all of the goods and services that are considered necessities.  The purveyors of "luxury" items (n.b., here I am not referring to what I'll call super-luxury goods, items of limited availability that are generally only purchased by the truly rich, the price of which have continued to rise sharply; I am instead referring to goods and services which are generally not considered to be necessities, the consumption of which is readily forsaken when resources are limited) have had to lower prices as their number of financially able customers declines.  As incomes stratify, more and more wealth is concentrated in fewer and fewer people.  While the rich may have more money, however, it doesn't mean that they need more things. Because concentrating the wealth in fewer and fewer people is unlikely to result in the same amount of spending as it would if it was spread amongst more people, the result has been a decline in velocity.   

So what you end up with, and where we are, is an overall low to no inflation to deflationary environment where the prices of necessities are rising much faster than the prices of "luxury" goods and other non-necessities whose prices may actually be declining.  To put this in economic-speak, the prices of inelastic goods are rising while the price of elastic goods are not.  As incomes become more stratified, more and more items will be deemed unnecessary because fewer people will have the incomes needed to purchase them, resulting in downward price pressure on those items and maintaining it on those still deemed necessities.  

Pushing more money into the system via QE and the like can be expected to have a negligible effect if that money doesn't reach the right people.  Pumping it into banks or buying debt from wealthy hedge-funds does nothing to accomplish this, only acting to exacerbate income disparity further.  As income disparity worsens, the price of non-necessities can be expected to fall, as fewer and fewer people can afford them.  As more and more items are deemed to no longer be necessary, the overall price level may still fall, in spite of all the money that's been pumped into the system, while the price of necessities like food, housing and healthcare continue to rise.  That fact alone should tell the central bankers of the world that the problem is not solely monetary in nature.  To address this issue, the deeper issue of rising income disparity needs to be addressed first, and any effort to do so which itself doesn't first admit that the issue derives from the shackles that government puts on creating opportunity is bound to fail.  

No comments:

Post a Comment