I was wondering what would happend if the total amount of money get fixed in an scenario were there is not exchange of good and services between countries markets. I think maybe the fact that prices could only decrease, it would make the labour force to decrease productivity because there wouldn't be the race for work to gain enough to not feel inflation.


1 Answer 1

  1. Yes prices would tend to decrease in such scenario. Deflation would lead to unnecessary unemployment, especially during times of economic downturn.

  2. Productivity depends on technological work and investment in physical or human capital (see discussion in Acemoglu Introduction to Modern Economic Growth). Inflation does not directly affect productivity or even just labor productivity. It also does not make sense prima facie, people make decision based on real wages $w/p$ and inflation, which is positive change in price level, erodes real wages. So it does not make sense this makes people somehow work harder/longer.

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    $\begingroup$ Why would deflation lead to unemployment? $\endgroup$ Mar 2, 2023 at 0:28
  • $\begingroup$ @DanielMuñoz because of market frictions in short run. In short run nominal wages are effectively fixed (or at least fixed in sense they can't decrease). This is due to unions, renegotiation costs that always exist with any contract, minimum wages etc. However, deflation means that prices of goods and services are falling, and this is not because they are cheaper to produce but just because of monetary aggregates. As a result firms now can produce less and hire less people until they are able to change/renegotiate nominal wages. This would be worse during recessions, as then the pressure $\endgroup$
    – 1muflon1
    Mar 2, 2023 at 9:52
  • $\begingroup$ having lower wages is highest, but again labor market frictions prevent instantaneous adjustment $\endgroup$
    – 1muflon1
    Mar 2, 2023 at 9:54

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