Three Reasons Why Lower Oil Prices Won't Lead To A 'Deflationary Spiral'

BI ^ | 2-1-2015 | Myles Udland

[blam]

Myles Udland
Febuary 1, 2015

Economists and central bankers hate deflation because of "deflationary spirals."

A "deflationary spiral" occurs when lower prices cause consumers to wait for even lower prices, creating excess production capacity, excess inventory, and ever-lower prices and so on. It is a circular pattern.

In a note to clients last week, Bank of America Merrill Lynch economist Ethan Harris took to task the idea that the deflation — or really, disinflation — that we're seeing due to the crash in oil prices will lead to a much-feared "deflationary spiral."

Harris outlines this basic sketch as what some members of the press, the analyst community, and even central bankers have said are the dangers of lower oil prices:

(snip)

[Will88]

Unless there has been a real expansion of the definition, deflation is falling prices due to a contraction in the money supply. Definitely not the case now with QE and other policies to increase the money supply and keep interest rates low.

[MCF]

Your reasoning is good, but I believe so many people are in such debit that most of the saved money will go to pay on loans and credit cards. Any up tic in spending will be small.

[SVTCobra03]

Gold will never go to zero.

[RegulatorCountry]

The QE was intended to replace the “money” destroyed in the massive credit contraction following the 2008 crash. Deflation has despite QE has continued to be a strong fear worldwide, and this oil price collapse is to an extent undermining QE. So, in that sense it’s deflationary.

[Will88]

The drop in oil prices is purely a function of supply and demand, increased production in the US and other areas and some decrease in global demand, and then the Saudi decision to keep production as is with the intent of driving prices down to undercut higher cost producers.

Deflation is falling prices due to a contracting money supply to the extent that the dollars that do exist will buy more, i.e., lower prices, or deflated prices to attract what money is in circulation.

Some are expanding the definition of deflation to include what is really increased supply and also some decreased demand. They can call it deflation, but it doesn’t fit the classic definition.

[Grzegorz 246]

“A “deflationary spiral” occurs when lower prices cause consumers to wait for even lower prices”

This is a serious threat but it doesn’t really happen once CPI hits -0.1%.