I like challenging combat, so I'm glad it's going to be tough. I said before I don't like the degrading armor/weapons thing, but since it's going to be in, I'm hoping that you don't go the Elder Scrolls route with reduced functionality (weapon damage for instance) for partially degraded equipment.
If you use a sword or whatever until it's broken or at 50%, and then it does less damage, that's fine. But in Oblivion, if your weapon was at 90%, it would only do 90% of its potential damage, which is just bloody awful.
I have to say again, if you want to fix the economy one sensible way is to cut down on merchants buying ingredients and other crafting stuff. A metal spring might be useful to a mechanic. Doesn't mean a merchant is going to buy it. To him, it's just junk.
Increased deterioration rate of melee weapons by 50% to somewhat balance out them not requiring ammo
This sounds terrible. IMO, melee weapons are already balanced against ranged in that your enemy is standing right on top of you when you use them. When you have to chase down five different guys with machine guns with your sledgehammer, you're not going to be patting yourself on the back for conserving ammo.