Why is deflation bad?

I recently argued that deflation ought to be a good thing. If everything gets less expensive over time, savers are rewarded, retirees on fixed pensions are rewarded, basic necessities become more affordable to more people. Shouldn't deflation be a boon to the poor? What's not to love? Well, plenty.

I'm reading Money by John Kenneth Galbraith. It is written with a dry wit that I find irresistible, and it's loaded with interesting tidbits. For example, Europe experienced a period of inflation after the New World was discovered. Large volumes of gold were imported, inflating the supply of supposedly "hard" money. It's a good example of monetary inflation, and also underscores a weakness in the gold standard.

Anyway, on the topic of deflation, Galbraith writes about a particular deflationary period. At the time, many farms were financed by loans. They had fixed payments similar to a mortgage, however, due to deflation, the farmers' income shrank. The price of a bushel of wheat dropped by something like 50% over the course of several years. Imagine if your boss cut your paycheck in half, but you still had to make the same mortgage or rent payments as before! That's the effect deflation has on debtors.

In a deflationary period, business are hesitant to finance expansion in part because they'll have to pay back the debt with more valuable currency. As a result, economic activity slows. As economic activity slows, business turns ever more sour, and employees must be laid off. Folks who are laid off are no longer able to afford their former way of life, so buying slows further, deepening the economic rut. Deflation can quickly lead to depression.

Our economy runs on debt. You might argue that it shouldn't, but as far as I can tell, every advanced economy that ever existed ran on debt. Unless we can invent a wholly different economic model, deflation will forever remain a real hazard.

I'll let Galbraith have the final word on the optimism with which we should greet economic innovation. "A constant in the history of money is that every remedy is reliably a source of new abuse."