[rondon2]

"So you get broad based increases in unemployment." I know it sucks to go from making 70k to making 60k but in a world where prices are going lower someone will still be able to have a similar quality of live at 60k. What kind of economic "Theory" would assume that people would rather starve to death than take a salary cut at another job?

[Chathamization]

The wage issue isn’t that people are choosing unemployment over pay cuts. It’s that companies will generally opt for a hiring freeze over a pay cut. Most places aren’t going to cut the salary of every team member by $10k so they can hire a new person, they’re going to put off hiring a new person and try to make do with what they have.

[rondon2]

That is only a temporary problem. Eventually employees will quit or die. And when that happens you will hire a replacement at current market rates.

[Chathamization]

Depending on your definition of temporary - as Keynes said “in the long run we’re all dead.” Eventually things will work themselves out, but how many years of self-imposed pain will it take? Employees are going to be much less likely to quit in a tight job market, especially if they’d be paid less at their new job (since, per your example, new hires would be paid less). If you’re waiting for employees to die (or retire, and they’re more likely to retire late in a tight job market), you’re talking about a price correction that happens once every several decades.

[skywhopper]

Except they won't keep the same quality of life, because their mortgage payments are not going to go down, even though the value of their house will. Renters won't get a break, either, because their landlords have to pay their mortgage with the rent money. Deflation equals disaster for our economy.

[rondon2]

The renter will get a break actually because newly constructed apartments are cheaper than the older apartments so he can move to a newer/nicer/cheaper place.

Deflation is a big problem for highly leveraged businesses and individuals. But for savers deflation is not a disaster at all.

[skywhopper]

But the cheaper place will never get built unless the builder can finance it without any debt.

[icebraining]

Except they won't keep the same quality of life, because their mortgage payments are not going to go down

Why not? They did these past few years in the EU. Are most mortgages in the US not pegged to some reference rate like Euribor?

[maxerickson]

The majority of US mortgages are fixed rate:

http://www.newyorkfed.org/research/current_issues/ci16-8.pdf

This is largely an intentional policy outcome, Freddie Mac and Fannie Mae were both intended to make mortgages cheaper (I think an interesting thing is that this doesn't necessarily make buying a house cheaper). It's increased since the recent crisis, part of the US response was to make money even cheaper (which favors locking in the rate).

[Jtsummers]

Can you point out what they did in the EU with this?

GP is referring to the idea that, under deflation, your debt grows in real value while retaining its nominal value, but the nominal value of your income will be decreasing.

If I take out a $100k mortgage and can put 10% of my salary to it each year, say I make $100k as well for easy math. I'll pay it off in 10 years if my nominal salary remains the same. (I'm ignoring the interest on the loan, it changes the timeline but not the fundamentals.)

If we have inflation, my salary will likely go up over time so each year I'll be spending the same nominal ($10k) amount, but its a smaller percentage of my income and a lower real amount.

If we have deflation, my salary will likely go down over time (assuming its consistent it'd likely be negotiated into employment contracts, like cost of living adjustments are now for inflation). So each year I have to pay the same nominal amount ($10k), but its an increasing real amount and a larger percentage of my income each year.

[icebraining]

But how can you ignore the interest? If the interest drops to along with your salary, you won't have to pay the same nominal amount each year - which is exactly what's been happening in the EU.

[dragonwriter]

> If the interest drops to along with your salary

With deflation, interest rates might be low [0], but they aren't likely to decline over time (unless the rate of deflation is increasing), whereas salaries will decline over time. So the interest rate won't drop along with your salary. Your salary will drop, and while the interest rate might (with the caveat noted previously) be low, its not likely to go down over time (if it does do so constantly due directly to deflation, that means your salary is likely not only declining, but doing so at an accelerating rate), your salary will be dropping both in nominal terms and proportional to the interest payments on your debt.

[0] but probably not; availability of credit will be low because risk-free instruments -- cash -- with a positive expected real rate of return exist, so there is little incentive to lend. Low credit availability doesn't make low interest particularly likely (it does make high interest rate volatility more likely, though.)

[Jtsummers]

For the calculations I ignored it. The discussion was inflation/deflation. Putting it in only changes my example by adding more arithmetic (calculating interest paid per period), but doesn't offer any insight into paying debts under inflation or deflation. EDIT: For the sake of this discussion pretend that the $100k paid includes the interest if you really want it to be there.

So in the EU interest rates are pegged to salary? Can it go negative? Because that's what needs to happen for loans under deflation to make sense. Your effective interest rate in a deflationary economy is deflation rate + interest rate. If you take out a 2% loan with 2% deflation your effectively paying 4% rates. The higher the deflation, the worse your rates become.

Now, if interest can go negative, then borrowing under deflation makes sense. But lending doesn't. Because the lender would be handing over money that would be more valuable kept under a mattress than loaned out at a negative interest rate.

[icebraining]

Your loans would become more expensive, certainly. It's still not correct to say that the "mortgage payments are not going to go down", which is what I replied to. They would - to a certain point, at least.

[dragonwriter]

> Are most mortgages in the US not pegged to some reference rate like Euribor?

There are both fixed and variable rate mortgages in the US, but variable rate mortgages usually have a minimum interest rate regardless of how low the index it is pegged to goes.

[pjc50]

Ordering and cashflow matters. If someone is just above being able to pay rent/mortgage+food+commuting+heating, and they get a pay cut, what happens?