Thursday, July 29, 2010

The Deflation Dream

I had a dream about deflation last night. In the dream, a 2-acre fire burned for a few days in the Denver area, and as a precaution, authorities closed several major through streets, creating traffic backups that also clogged the expressways. With traffic not flowing, retail stores were all but abandoned. In a desperate move to boost sales, they cut prices across the board, creating what the radio commentary called "a 25 to 30 percent off sale on virtually the entire city of Denver."

Setting aside the dream logic involved in this story, if there is going to be deflation, it's going to happen like this, with a series of large price cuts triggered by calamities. It's not likely to be the result of retail and wholesale price cuts of 1 percent every few months as a response to steadily decaying demand, which seems to be the scenario that a small contingent of economists is worrying about.

U.S. commercial culture doesn't support small price cuts of less than 10 percent. Sellers are better off holding prices steady until they can announce a price cut large enough to get people's attention. I expect that this effect alone will be enough to hold off any deflationary tendencies that might develop.