Is deflation per se "bad for the economy" or "important to avoid"?

Question

In standard economics deflation is marketed as "bad for the economy" or "important to avoid" in the sense that it leads to a stop of consumption because consumers wait with consumption expecting prices to fall even more thus leading to a "neverending" downwards spiral in the total economy.

While this way of thinking has historical references, I wonder: if we would normalize deflation, wouldn't it lead to more cyclical economies with minor deflation cicles? Economy itself is one of the only aspects in life which seem unnatural, not obeying to ups and downs, cyclical motions but just a constant upwards flow.

EDIT: Due to some valid remarks in an answer and comment, the origin of the question lies in the observable phenomenon that consumer prices usually never adapt downwards. Products which raise prices due to a raise in oil prices (logistics, detail products where logistic costs are included, etc), usually do not adapt downwards if oil prices fall; usually in best case, they remain the same. Also the focus is not necessarily the pure scientific theory but how that is lived in our real-world, because if managers are tought, that deflation is important to avoid, they have no reason to lower prices even if the driver for raising prices (like oil price) has gone down again. At least that human behaviour is the driver for this question

After the pandemics we observed a worldwide stagflation, where prices increased in such way that wages didn't follow, thus leading to a more moderate consumption, or from a consumer perspective to a more selective consumption of essential goods in disadvantage of less-essential goods and services.

Deflation, if it would be more normalized, could theoretically counter-effect a stagflation thus impulsing the economy earlier and/or avoid crisis in some economical sectors. Because, and that is where my question is coming from: Stagflation post pandemics lead to a re prioritizing in consumption anyway: People didn't stop consuming but they had to focus on essential spendings, leading to a preference on essential or cheap (china or worse quality) articles. A slight deflation could have helped to avoid closing down of lots of smaller businesses which sell non-essential goods or cannot compete with big businesses which can lower margins. Also in nowadays most well-being societies it's unrealistic that consumption comes to a full stop: people cannot afford to wait forever to buy bread, fuel, buy new machines if repair costs are too high, etc. They do not want to lower their standard if avoidable. Also people are accustomed to a state of well being so in most societies they buy new shoes or clothes if the old ones have holes anyway, because of social status or simply because their being accustomed.

So from that behavioral economics point of view: would a slight and short deflation not be better than a longer stagflation for economy? (parting from nowadays well-being societies). Couldn't be that minor deflation cycles (which I believe would be much more limited than 50 or 100 years ago) would impulse the economy faster and avoid other disasters as higher unemployment or stronger shifts in the company landscapes?

PD: I know it depends very much on the country too. For example Switzerland has mechanisms to control inflation to a max of 2% per year, thus guaranteeing stability in crisis, while for example Chile is full neoliberal (more exposure to crisis) and thus was hit very hard with the pandemics aftermath of inflational prices (20% and more depending on the sector). So in my mind, at least theoretically, slight deflation could reduce volatility in markets, and guarantee more stability, if more normalized.

Answer 1

Is deflation per se "evil"?

No, it isn't, nor is this a view modern economists have. I do not believe one could provide any reference to modern mainstream text that considers deflation as "evil".

In standard economics deflation is marketed as "evil" in the sense that it leads to a stop of consumption because consumers wait with consumption expecting prices to fall even more thus leading to a "neverending" downwards spiral in the total economy.

This is simply not true. A standard and widely used macroeconomic textbooks such as Mankiw Macroeconomics, Blanchard et al Macroeconomics, Romer Advanced Macroeconomics, Woodford Interest and prices all have large dense chapters on inflation and none of these labels deflation as "evil".

Next, the second part is also not true. Deflation has two effects. First, it has intertemporal substitution effect where it incentivizes people to consume less today, but also to save more today (which boosts incomes and output through more investment spending, which can either fully or partially offset the drop in consumption). Second, it has it a wealth (Pigou) effect, as it increases people's wealth and this expand consumption both in the present and in the future (see Mankiw Macroeconomics 9th ed pp 354).

So one cannot a priory say that deflation leads to fall in consumption, nor it necessarily lead to "never-ending" downward spirals. Economic spirals are not automatically never-ending, it depends whether the series is divergent or convergent. A convergent infinite series, will not end in a forever spiral. Only divergent series would.

Deflation is primarily problematic when economy is in a deep recessions and less problematic in milder recessions (see Atkeson and Kehoe 2004), where investment becomes unresponsive to extra saving, but since macroeconomically $I=S$ this imbalance is resolved through fall income when S increases such that $I=S$ because you are now saving from less income. This is called paradox of thrift or saving (see Blanchard et al Macroeconomics 3rd ed pp 53).

Moreover, because of sticky wages or prices, deflation, in the short-run, leads to above equilibrium levels of unemployment and output gap, but these close in medium to long-run when prices become flexible.

While this way of thinking has historical references,

I do not believe there are any historical references for what you describe. First, this kind of value laden language, calling phenomena evil, is not really used in economics for about last 100 or even more. You would at best find that kind of language in very old tracts. Moreover, there isn't anyone in economic history (see Brue and Grant History of Economic Thought 8th ed) who would think deflation always results in never-ending spirals.

, I wonder: if we would normalize deflation, wouldn't it lead to more cyclical economies with minor deflation cycles?

I am not sure how you define deflation cycle, deflation would lead to deeper recessions according to modern models with more unemployment (e.g. see discussion in Mankiw Macroeconomics 9th ed ch 12).

Economy itself is one of the only aspects in life which seem unnatural, not obeying to ups and downs, cyclical motions but just a constant upwards flow.

There isn't anything unnatural about constant growth. In nature, volume of universe always increases, entropy of universe also always increases, time seems to flow in one direction so, so no matter how you measure it, passage of time also constantly increases.

This being, said there are no economic laws that say economy has to constantly grow. Economic output is primarily determined by technology. A typical production function you will find in economics will take following form $F = AK^{\beta}L^{1-\beta}$ with $0<\beta<1$, where $A$ is stock of knowledge/technology, $K$ is stock of capital, and $L$ stock of labor, more factors such as land or human capital (education) can be added.

Now, as long as there is no limit to the amount of knowledge humankind can generate, there is no practical limit to economic growth. So far our civilization did not hit the celling of the possible knowledge, and moreover, during last 200 years our technology/knowledge stock rapidly expanded, so we observe in data continuous growth without any hint of stopping. However, decline is possible when knowledge is lost (like during the fall of Roman Empire) or when the institutions that precipitate generation and diffusion of knowledge, and also production in general (e.g. institutions that lead to efficient allocation of capital and labor) are lost (e.g. see Acemoglu & Robinson, Why Nations Fail?).

Moreover, the "upward flow" is far from constant. Economies are constantly being perturbed by shocks and although output does trend upwards, there is great amount of jumps and downs around that trend. This is especially true for output of individual countries, since for the world as a whole some of the jumps and downs in output average out (see world bank data).

Deflation, if it would be more normalized, could theoretically counter-effect a stagflation thus impulsing the economy earlier and/or avoid crisis in some economical sectors.

I do not know what kind of theory are you referring to and I do not believe there is such a theory. Stagflations are typically caused by shocks to aggregate supply (see ibid 455-458). Deflation doesn't really affect supply side, but it affects demand side. I don't see how can you argue that creating negative demand shock somehow helps to resolve negative supply shock. Moreover, I can't even imagine how this could be practically done since these shocks are typically idiosyncratic.

Stagflation post pandemics lead to a re prioritizing in consumption anyway: People didn't stop consuming but they had to focus on essential spending, leading to a preference on essential or cheap (china or worse quality) articles.

There wasn't really a stagflation post pandemic, because US economy (assuming you are talking about US) grew at solid pace after the pandemic. The stagflation indicators showed some signs of possible stagflation, but then the indicators fell sharply since inflation came down. In US according to data there were so far only 2 periods of stagflation, one at the beginning and one at the end of 70s (see stagflation indicator for US). Hence, if you are talking about US you are talking from false premises. If you talk about EU, there the problem is lack of competitiveness and effective investment into R&D and its diffusion (see Draghi's Report).

A slight deflation could have helped to avoid closing down of lots of smaller businesses which sell non-essential goods or cannot compete with big businesses which can lower margins.

I don't understand based on what you come to this conclusion. To my best knowledge there is no economic theory, mainstream or heterodox, which would make this claim.

Also in nowadays most well-being societies it's unrealistic that consumption comes to a full stop: people cannot afford to wait forever to buy bread, fuel, buy new machines if repair costs are too high, etc. They do not want to lower their standard if avoidable. Also people are accustomed to a state of well being so in most societies they buy new shoes or clothes if the old ones have holes anyway, because of social status or simply because their being accustomed.

First, well-being society is not really a term that is used, so its not clear what exactly you mean by that. Second, as was already explained, there aren't any economists who would claim that as a result of deflation consumption would stop. In fact even in basic economic models we typically always include autonomous consumption (i.e. consumption that will occur irrespective of factors such as deflation). This seems to be a respond to some sort of straw man argument.

Hence, this does not really change anything. Economists do already acknowledge that portion of consumption is autonomous (e.g. see ibid 336). Economic models that show deflation supresses output and employment during recessions already factor in the fact that some consumption will always occur.

So from that behavioral economics point of view: would a slight and short deflation not be better than a longer stagflation for economy?

First, what you talk about has nothing to do with behavioral economics. Behavioral economics studies how deviation from rational (i.e. consistent) behavior affects economic outcomes. An example, of behavioral economics applied to this problem would be to study how hyperbolic discounting (inconsistency between present and future preferences) affects consumption under deflation.

To my best knowledge, there simply isn't a behavioral macroeconomic theory that would say something more on deflation than standard macroeconomics, although behavioral macroeconomics is a relatively new field. Nonetheless, in your question you are not really using behavioral model (or if you do the question does not show that).

Second, that is a false choice fallacy. There isn't really a solid theory or empirical evidence showing that slight and short deflation can prevent stagflation. That is like asking wouldn't it be better if earth was perfect sphere rather than oblate spheroid? If we would be allowed to choose between the two you can make aesthetic arguments for sphere, but its not like we have choice. Similarly, there isn't any evidence for deflation/stagflation trade-off.

In a thought experiment where this trade-off exists, the answer would depend on policy maker's or people's preferences. A priory without examining preferences there isn't an objective answer by which one of the option is better. But since this is a false choice, this point is moot.

Couldn't be that minor deflation cycles (which I believe would be much more limited than 50 or 100 years ago) would impulse the economy faster and avoid other disasters as higher unemployment or stronger shifts in the company landscapes?

Again, within modern economics there isn't really any evidence for such trade-off. Also, deflation will lead to higher unemployment in deep demand driven recessions, less so in mild ones as discussed above.

Answer 2

Deflation is perfectly fine and natural in a market economy with sound money. During the post civil war era in the United States prices fell over several decades and this was a time of substantial economic growth.

Nor is the deflation that occurs during recessions problematic. Indeed, it was precisely the efforts of Hoover and FDR to prevent falling prices that so aggravated the depression of 1929 and made it so great. During a recession, prices including wages fall and this assists in the reallocation of factors which is required to fix the recession.

Wages don't have to be sticky, that is ideological. Again during the 19th century wages did adjust downwards during recessions. Anyway the whole thing is a moot point, since by having sound money we can avoid the whole business cycle in the first place.

Answer 3

Since the nice answer does not reference anyone outside the Keynesian, post-Keynesian or new-Keynesian adjacent theories, I shall enrich the conversation:

Huerta de Soto writes:

business cycles are a practical example of the errors in economic calculation which result from state interventionism in the economy (in this case in the monetary and credit fields)... in other words, we could consider the entire contents of this book as simply the application of the theorem of the impossibility of socialist economic calculation to the particular case of credit and the financial sector.

Austrian Business Cycle Theory, which is, basically, referenced here defines inflation as:

(...) an increase in the money supply. This is the proper understanding of the phenomenon which gives us a grasp on its identity and causes. Inflation is not, as per official government definitions, some sort of change in an arbitrarily constructed price index. Changes in the prices of consumer goods is a common effect of inflation, but not inflation itself. (...) (T)he government via its symbiotic relationship with a privileged banking system is the cause of inflation, a fact politicians will want to distract attention from. Hence, by focusing on an effect of inflation, the cause is left mysterious and can readily be blamed on greedy businessmen or capitalism itself. (THE MISES-HAYEK BUSINESS CYCLE THEORY, Robyn Harte-Bunting, 2012)

Mises adds a few choice words in the topic:

One can say without exaggeration that inflation is an indispensible intellectual means of militarism. Without it, the repercussions of war would become obvious much more quickly... war-weariness would set in much earlier. (Mises [1998] p. 442).

Following that explanation is the pointing out that fractional reserve system (note: US at this time has 0% fractional reserve requirement) is vital to both injection of the inflation into the system and maximize the gain of the players, with description of the role of major players:

Rothbard (2004 and 2008) has shown why the banks need to cartellise in order to make sure that local crises do not erupt such as one bank being unable to honour request for redemption of its notes by another, and Rothbard also goes on to explain why the entire system requires a lender of last resort (the central bank) to keep the whole system going. Crisis erupts in fact when the banks simultaneously find that the value of the loans they have made is impaired (they are investment errors) and when the general public begins to lose confidence in the system. Hence, the central bank exists as a means of «injecting liquidity» (effectively printing money) to shore up banks reserves when they are diminished by losses and withdrawals. The very fact that the system requires such «confidence» is a key to the understanding that there is no real economic basis for much of the economic activity that the banks stimulate via their loans. If there was such a real basis, it would not matter if people had confidence in it or not. (THE MISES-HAYEK BUSINESS CYCLE THEORY, Robyn Harte-Bunting, 2012)

Having all that in mind, and being familiar with "The Hayekian Triangle"

we can, following Garrison's work infer that inflation is the distortion of the credit supply in the market:

in effect decreasing the efficiency of the investments and finally decreasing the output of production or consumption.

ABCT, following logically, defines deflation as

a possible consequence of the prior credit inflation.

The more sudden can be the deflation - most often in the form of a final banking collapse - the more re-inflation attempts continue after the inevitable bust after the artificially stimulated (by inflation) boom ends.

This happens because of the core idea behind inflation being required to restore economic growth by increase the money supply,

(...) effectively to reflate -bank failures attending the contraction of course have the effect of deflation. This approach ignores, because of the poverty of [monetarist] theoretical model of capital, the distortions caused by the earlier inflation which would be left in place and in fact exacerbated by such a policy. (...) It is also unclear as to what any coherent general monetarist position is on the general causes of bust in the first place as they cannot cite, given their commitment to the homogenous capital theory and neutral money doctrine, the cause as a distorted pattern of investment and unsustainable consumption. (...) Indeed, the monetarists entire position appears to rest upon the fallacy that an expansion in money is needed to serve industrial expansion. (THE MISES-HAYEK BUSINESS CYCLE THEORY, Robyn Harte-Bunting, 2012)

So, to bottom line the smart words above: Inflation is the result of government meddling in the economy, inevitably leading to an instability and a subsequent "financial market crashes", following by deflation as being a "correction" of the prior inflation. If this is paired with "the lender of last resort" (i.e. central bank), all that's happening is the bankers getting fatter on their credit expansion, with losses transferred to the taxpayer.

From that we can answer the OP question: deflation is neither

per se "bad for the economy" or "important to avoid",

because it is the inevitable and necessary cure of the "bust" following the "boom" caused by inflation.