Pigou! Bless you.
The Pigou effect in economics describes the theoretical cause-and-effect relationship between deflation and other factors, like wealth and consumption. Let’s take a look at what Pigou was pigging on about.
During deflationary times...rare times, indeed...the poor man is suddenly rich! Well, richer. Deflation means prices go down, which makes your hard-earned dollars worth more than they were before. That’s kind of the same thing as if your income went up, like if you got a raise. And what would you do when you get a raise? No, you’re not going to be a responsible person and put it all in your retirement accounts. Arthur Pigou believed you’d spend...at least a bit more than before.
So deflation means increased wealth, and therefore increased consumption. What about employment?
The same logic applies: employers have more dollars to spend, too, which means more workers to buy. And they’ll be needing to hire more workers, because increased consumption means increased demand for stuff. Supply’s gotta meet that market demand somehow.
This whole thought process is pretty anti-Keynesian, since Keynes thought the Fed should do something during deflationary times. Arthur Pigou said we can chill during deflationary periods, since the market will self-correct: prices go down, wealth goes up, spending goes up, employment goes up, naturally.
There are anecdotes for and against the Pigou effect, but a funny one happened in Japan. It was thought that people weren’t spending more when prices fell in the 1990s because, like short-term traders, they thought prices would keep falling. Why buy now when you can buy later, if prices are continuing to fall?
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Finance: What is Deflation?4 Views
Finance, a la shmoop. What is deflation? Alright well let's start with inflation [A football with a pump attached]
and here's the proverbial football we pump as prices go higher and higher [The football getting bigger and starts to shake]
until they can well go no more. But the real world doesn't have to be this [The football explodes]
dramatic in fact prices inflate and deflate in small pieces all the time. The [Graph showing historical inflation rate]
standard terminology for when pricing goes down relative to well everything [2 dollar price tag is replaced with a 1 dollar price tag]
else at least the indices in its past, well that term is deflation. There are
really two types of deflation economists drone on and on about and they come from [Students in class asleep]
very different places. Over here is simply monetary deflation that is the [Types of deflation written on a blackboard]
supply of money, think liquid cash sloshing around in the market places, [Tap running in a basin labelled marketplace]
that money supply declines in monetary deflation. All right so what does that [Money running out of the tap]
mean to the average Joe well it means that wages and money generally go
further in times of deflation like your dollar buys more than a dollar, at least [Someone putting money into their pocket]
what a dollar bought last month or last year. And that's the direct opposite of
what happens in an inflationary environment, got it? [Money disappearing]
So that's monetary deflation but the other flavor of deflation is price
deflation which implies that prices on the basics well are simply going down
driven usually by consumer fear of a bad moon on the horizon, where consumers [Girl looking scared and crying]
simply don't buy things and via lack of demand prices well they just sag into an [Someone putting a bottle of wine back onto a supermarket shelf]
overly supplied abyss and you know the saying life's abyss and then you die you [Price tag flies off a tag]
know that's where it came from. Well alternatively if productivity goes
way up well then consumer purchasing power also goes up with it and then we
likely get inflation, got all that? So this is supply and demand and there's
the graph and when demand goes down supply goes up and prices get weak [Supply and demand graph]
Wifi used to be expensive because the technology to deliver it was really hard [Picture of a complex circuit board]
to build and distribute and have actually work, but then tons of Wi-Fi [The circuit board starts smoking]
devices got out there i.e. there was tons of supply and well now there's Wi-Fi
everywhere and so pricing is cheap if not free pretty much well everywhere so [Wifi symbols popping up all over the world]
think about that as a supply driven deflation and you know Wi-Fi prices [Graph showing price of wifi falling]
they're going down and yeah that's really about it if you were hoping for
more elaborate explanation we're sorry to bust your balloon... [Balloon explodes]
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