Positive side to deflation

Even though Bitcoin’s deflation is a terrible prospect from a macroeconomic perspective, it could be a good thing when viewed from a microeconomic perspective. For example, inflation tends to make people miserable. Economists researching the effects of inflation on happiness discovered that “that a one percentage point higher annual inflation rate makes the average European less happy by the same amount as would a loss of $70.” The reason for this seems to be irrationality, as people focus on the bad side of inflation which comes down to rising prices. This is despite the fact that inflation also means rising wages.

Inflation tax

Deflation may also produce a welfare gain, as inflation reduces the real value of your holdings. This is why inflation is sometimes referred to as a tax on holding money. As with any tax, it tends to make us worse off. Inflation also reduces gains from saving. Bitcoin does not pay any interest. But deflation, even without any interest, can still leave you better off than an interest paying savings account. Assume that a savings account pays three and a half percent interest, the inflation rate is two percent and 20 percent is taxed. The post-tax real interest rate would be just 0.8 percent. If no interest is paid, a deflation rate of just one percent would still lead to a bigger increase in welfare. It is said that the ideal rate inflation should be slightly negative for the optimal effects, as this abolishes the inflation tax.

Long way to go

As Bitcoin has seen its value skyrocket in the past years, it is nowhere near a slight deflation rate. But Bitcoin will not become a purely deflationary currency until 2040, when it reaches its maximum coin supply. From a microeconomic perspective, this could still end up working out well for Bitcoin.

Leave a Reply