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Why invest or take any risks at all if the cash in your mattress is going to be worth more a year from now anyway? And this is as true of companies as it is of individuals. With no risk taking or capital expenditures, things get pretty slow.
Isn't this true today though? We have relatively risk-free options today such as savings accounts. Returns from those risk-free options are positive, yet massive money still flows into riskier assets like stocks in the hunt for higher returns.
Wouldn't the same return-seeking behavior be in play in the hypothetical economy under discussion, one where productivity-driven deflation was allowed by the Fed during normal economic times? A person could stuff money under a mattress for a 2%/yr return via purchasing power increase, but when other similarly risk-free options like savings accounts are available with higher real returns, why would they? Especially with the risk of house fires and theft :)
Plus, if significant mattress stuffing or the like did occur, wouldn't a reduction in money available to loan lead to higher market-driven interest rates, luring people to pull more money out of mattresses? (an equilibrium effect?)
What am I missing?
