The _really_ scary thing is that as rates are moved close to 0, inflation seems to slow down. This is true both in the US (almost 0 rates, low inflation) and in the EU (a bit higher rates, but almost 0 inflation in the last few months). If deflation kicks in, then this flood of free money will evaporate very quickly.
This jump is a result of the Fed getting authorization from congress to pay interest on said reserves. By controlling this rate, the Fed can effectively control how much excess reserves they have, thus having a large impact on the rate of inflation. Having said that, it is a massive and unprecedented amount of excess reserves. If something goes terribly wrong in their exit strategy (and/or the velocity of money picks up unexpectedly) then the worry would be high inflation, not deflation.
EDIT: I believe you meant if inflation kicked in then the flood of free money would discontinue. That would be accurate as interest rates would rise and QE would most certainly be off the table. Deflation fears is what set QE into high-gear in the first place ;)
Economics aren't discontinuous around zero. All this evaporation would either happen approaching zero or not happen.
Deflation does not mean spending money is a bad idea. If I have $100 and there's 10% deflation, in a year, it's worth $110 of today's dollars(or some other number because I can't math, but in that general direction). But if a company is experiencing 100% growth and is worth $100 today, it's still a good investment (if you can sell it in a year).
The Eurozone is looking at mild deflation, and it will do a lot of damage. Deflation in the US is nearly impossible, because the FED will just purchase assets until the problem of low inflation goes away.
Deflation in the Eurozone will be bad mainly because it will make the personal and public debts of the debtor nations unbearable. Not because "money will evaporate very quickly".
This is standard excuse trotted out. Of course it is incomplete at best and grossly misleading at worst.
Deflation is the opposite of inflation. One is an increasing value of currency, and the other is a decreasing value of currency.
People deal with deflation every day - both in their own national economies and internationally - when your currency is rising (gaining value) why would you purchase something today when it is going to be worth more tomorrow? The answer is because the value of having the thing today is worth more than having the money tomorrow - which is how we base all our purchasing decisions.
It's true that deflation will have effects that are not good - but mild deflation is no horrific thing. Most people have been told deflation is a scary monster in the same way that they have been told marijuana is a scary drug. There are circumstances and reasons when that is true, but it's not generally true and generally overblown. Both high deflation and high inflation are runinous to an economy, but mild deflation and mild inflation just produce different classes of winners - savers vs creditors.
What people actually mean when they say "buy something" is "invest in something".
When an investor chooses whether to invest in something, the question they ask themselves is "will this make more money than the best alternative investment on offer to me?"
When the value of currency is falling, it becomes relatively more appealing to invest in things that are not currency. For example, new machines for the local factory - those machines make widgets, and with 2% inflation those widgets are worth 2% more every year.
When the value of currency is rising, it becomes relatively more appealing to invest in things that are currency, like keeping my money in the bank. Glad I'm not one of those suckers who invested in the widget factory, because of the 2% deflation those widgets are worth 2% less every year.
Me, I think our economy would be better off with more invested in manufacturing and less in financial services.
>because of the 2% deflation those widgets are worth 2% less every year.
Also, the value of your loan increases in real terms, as does the labour-share of input costs (because the workers aren't going to give back wage gains in times of deflation). Your return is hampered.
True. Creditors vs Debtors. Creditors are advantaged by deflation, debtors advantaged by inflation. Except where effects of one or the other affect the amount of bad debts.
Other EU countries with their independent currencies/central banks have gone the same way as the Eurozone: Sweden just went into deflation and UK seen inflation go below their 2% target (designed for normal times, arguably should now be higher) as well.
