Effects of the deflation on debt

The blue line is the price level index and the green one the medium average of the period. We are in the same price level than at the beginning of 2013 –without a clear trend upwards or downwards. If it cannot be technically defined as “deflation,” then it can be defined as “price stability.”

From the point of view of the accumulated debts by the institutional sectors, it is not a good perspective. A stable price level would be good if it only existed in the real economy. However, we live in an economy with money, credit and uncertainty, which doesn’t start from zero each day. When you get up, you already have debts for several years and long lasting assets that are financed with those debts.

With a fixed price level it is much more difficult to get rid of the debts. The more the nominal income (real income + prices) increases, the looser the payment of bills and the debt maturities will be.

Furthermore, price inflation impacts on wage inflation. With wage inflation at zero, wages will not increase: businesses cannot increase salaries if the sales prices don’t go up –unless there is a significant rise in productivity.

Besides, the entrepreneur also has to return his own debts and now they don’t find it easy to obtain banking credit. Let’s include the uncertainty about what will happen in the future…

For the time being, inflation is not an absolute evil. On the contrary: it is the lesser evil when compared to deflation, i.e. production and debt stagnation.