The quantity of money in the Finnish economy has decreased and triggered a deflatory process. Deflation remains invisible at the beginning of the trend because sellers prefer to leave commodities unsold rather than reducing the price. Another explanation is known as Duesenberry Paradox suggesting that people with sudden drop in income make use of savings and credit before adjusting consumption to the new level of income.
Author: Mauri GrönroosPoliticians and decision makers, among them Mr. Erkki Liikanen, the Governor of the Bank of Finland keep comforting citizens and businesses about this issue. There is no deflation at sight in Finland although it already lurks in the crisis states of Southern Europe (Lynn, 2014). But this is self-delusion. Finland is already in a deflation and the downward spiral only accelerates as soon as the message reaches the common man.
Supply exceeds Demand
Prices notoriously go down because of competition or an increase in productivity. This is not called deflation. Real deflation emerges if the quantity of money in the economy decreases. The result is more commodities and services than potential buyers have money or credit to buy them. The supply of commodities exceeds the potential demand. This is the situation in many European countries. Salaries have remain constant for several years, consumers’ net income shrinks because of constant increases in taxes, fees and charges on income, housing, energy, transportation, and many more. Unemployment is increasing rapidly, hidden unemployment is off limits, many people have been hired only temporary or have desperate zero-hour employment contracts. In addition, there is an army of society drop-outs hanging around in shopping centers, individuals who simply give up and stop looking for a new job and the remains of the baby boomers who retire in the next few with income to be cut in half. There are also many special groups, such as students with shrinking resources to spend or more affluent people who just sit indecisively on their wallets and wait.
If an average consumers’ income has without doubt decreased why would prices not just drag along clear enough to wake up the last doubter? There are two reasons for that. Firstly, deflation remains invisible for a long time. Secondly, the effect of the Duesenberry Paradox reduces the speed of the downward spiral of prices. In times of inflation price increases visibly but in deflation prices seem to decrease at diminishing rate. Expensive commodities simply remain on the store shelves. The turnover of an upper-end department store Stockmann has nose-dived. The reason is not that consumers prefer to buy online but the price image of the store is far too expensive in today’s economic environment. Houses in suburbs are unsold not because families don’t prefer to have more living space but many of them fear that one or both of the spouses cannot keep their job until the mortgage is paid. Barkeepers complain about consumers buying beverages from Estonia and drink at home instead of enjoying drinks in bars and pubs. If offered goods or services cannot be sold, the reason is often believed to be something else than high price that is simply too high for potential buyers and their current or expected income.
Keep up with the Joneses
James Duesenberry (1918-2009) made a finding that individuals consumption can easily pick up if income increases but it is hard to reduce if the income diminishes. As a result, the consumer resorts to savings or runs into debt. The phenomenon is called a paradox because it is not quite clear why this happens. Duesenberry himself believed that people try desperately to maintain their level of consumption because of their peers, trying to keep up with the Joneses (Duesenberry, 1952). However, when the reserves are gone it is finally time to adjust to the decreased income. Deflation advances in many other areas, too (Dent, 2014). Prices of large town apartments fall because the retired with no more kids at home do not need so much space. The unemployed is forced to accept a job with lower pay as unemployment benefits are running out. Living space will shrink and the cars will be older and smaller. In ten years Finns will still grill meat but instead of sirloin it will be hamburgers.
The positive part of the news is that the ongoing and accelerating deflation will lead to the very much yearned-for internal devaluation, that is, as prices and salaries go down Finland’s lost price competitiveness will be restored.
About the author
Dent, H. S. 2014. The Demographic Cliff –How to Survive and Prosper during the Great Deflation of 2014–2019. New York: Portfolio/Penguin.
Duesenberry, J.S. 1952. Income, Saving and the Theory of Consumer Behavior. Cambridge, Mass.: Harvard University Press.
Lynn, M. (2014, March 12) Europe’s Hot New Export is Deflation. Market Watch. Matthew Lynn’s London eye. Retrieved 13.4.2014. http://www.marketwatch.com/story/europes-hot-new-export-is-deflation-2014-03-12