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?
Related or Semi-related Video
Finance: What is Disinflation?4 Views
finance a la shmoop what is disinflation disinflation often confused with dat
inflation refers to the decline in inflation rates over time in 1973
America was fully juiced with Warbucks from Vietnam inflation hovered around [soldiers firing weapons]
the mid going on high single digits and then higher from there like 7% or more
depending on where you look him and Jimmy Carter stepped in on this guy and [Carter walks into office]
raised the federal rates the Fed rates their massively stamping out the wild
bull economy and putting the brakes on inflation but it didn't happen until
after Carter was actually out of office and Reagan took over inflation [Reagan replaces Carter in office]
eventually had rocketed all the way up to about 14 ish percent on an annualized
basis looking at the monthlies in the 1980-81 period right here
well the crux of dis inflation is that inflation is still positive it's just
becoming well less positive and or like you know how you feel not long after you
say I do and the honeymoon is over and you have to take out the garbage so
under Carter the US inflation rates were attacked in a variety of ways the [Carter in a boxing ring]
biggest of which was to make the cost of renting capital very expensive which
cooled the economy but it took a long time like note how slowly inflation
rates came down and well really it was decades before things fully stabilized
you can see how things slowly disinflation the raging levels that
peaked at post-vietnam era 1314 percent then slid all the way down to a 1 to 3
percent way down there where it's hovered for a
while so that's disinflation still inflation but just less of it deflation [Disinflation deflating]
is when inflation turns negative like prices are actually declining and yes
we've had periods of deflation before albeit very short ones like in the post
mortgage crisis Mallove's in 2009 right here yes yes it's rare but it happens
got it okay class dismissed
Up Next
What is a recession? Luckily, it has nothing to do with your hairline...hit play to find out more.
Price deflation is when pricing declines relative to past indices; monetary deflation is when the supply of money declines.