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Just to be clear, it's an argument against fiat currency as deflationary and inflationary shocks occur in those systems. The effects of deflation and inflation over time are countered with market-set interest rates -- higher savings and loan rates in an inflationary period and low-to-negative rates in a deflationary period. Yes, in a deflationary economy a (for example) -5.00% interest rate might be fair and would happen were it allowed.



Why would you ever lend money at a negative interest rate? You can always get 0.00% with virtually no risk just by socking the money away in a secure location. This is the heart of the problem with deflation (and deflationary currencies like bitcoin) - there's a 0.00% floor on the time cost of money.


Yes, you are right of course. The interest rate could not rationally go down below zero, but there would still be demand for loans during the deflationary period, so there would be other compensation (like equity in a business) in exchange for the load so that the risk/return would be proportionate to the risk-free rate of holding cash.


There will certainly be demand for loans, but the supply and demand curves for loans may not intersect anymore, meaning that no loans are made (because given a deflation rate of 5%, a nominal interest rate of, say, 1.5% (only a very small premium over the minimum risk-free rate of 0.00%) is still a real interest rate of 6.5%, which may be more than many of the loan customers are willing to pay.

In other words, deflation makes financing any risky enterprise much harder, so only the mostly highly profitable projects succeed. This makes sense, because in a deflationary environment just holding a pile of cash is a profitable endeavour.




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