Deflation

Definition:

Deflation is a general decrease in prices and wages, accompanied by a decline in overall economic activity. It is the opposite of inflation.

Causes:

• Demand-pull deflation: Occurs when aggregate demand decreases, leading to a decline in prices.
• Cost-push deflation: Occurs when production costs increase, but demand remains unchanged, leading to a decline in prices.
• Built-in deflation: Occurs when inflation expectations decline, leading to a decrease in demand.

Effects:

• Increase in purchasing power: Consumers can afford more goods and services with the same money.
• Reduction in economic growth: Deflation can lead to a decline in economic activity, as investment and consumer spending decrease.
• Debt burden: Deflation can increase the burden of debt, as interest payments become cheaper relative to inflation.
• Financial instability: Deflation can lead to financial instability, as banks and other financial institutions may become more cautious.

Examples:

• A decline in consumer spending due to a rise in unemployment.
• An increase in production costs due to higher commodity prices.
• A decline in inflation expectations due to a weakening economy.

Measures to Combat Deflation:

• Expansionary fiscal policy: Government spending and investment increase.
• Expansionary monetary policy: Lower interest rates and increased money supply.
• Increase aggregate demand: Policies to encourage consumer spending and investment.

Note:

Deflation can be a complex phenomenon with various causes and effects. It is important to consider the specific circumstances and underlying factors before making any interpretations or drawing conclusions.