Why Is Deflation Bad for the Economy? By Adam Hayes Updated October 1, — 7: Today, the economies of the Eurozone are combating deflation, and the European Central Bank ECB has even been taking the extraordinary measures of undergoing quantitative easing.
Share via Email For the past four decades macroeconomics has focused on how to reduce and control inflation.
All the remedies now considered orthodox - such as the independence of central banks, the primacy of inflation targets, the need for fiscal prudence, and the wickedness of "printing money" - stem from the experience of the s, when profligate governments allowed inflation to run out of control. But inflation is not always the main problem, or indeed a problem at all.
Sometimes, though rarely, deflation is a more serious threat, and we need to shelve many of the orthodoxies we have held so dear.
Now is such a time. Deflation and depression are closely related. This week the UK has reported the sharpest drop in producer prices since the series began inand unemployment has reached an year high with the largest jump in claimants since The Bank of England is forecasting a severe recession similar to the one that hit the Scandinavian economies after their banking collapses of the early s.
This, and the collapse in commodity prices, makes it likely that consumer price inflation will disappear completely before the middle of If economies weaken only a little further than now feared, then we will experience deflation. Deflation is defined as a pervasive decline in the general price level, not just a decline in the relative prices of a few goods which is an inevitable feature of a healthy competitive economy.
When such a decline starts, three very dangerous things can happen. First, real inflation-adjusted interest rates rise, and the central bank becomes powerless to prevent this, because it cannot reduce the level of nominal interest rates below zero.
As the rate of deflation gets larger, the real rate of interest actually increases, and this perversely tightens the stance of monetary policy.
Second, the real level of debt in the economy also rises. This process of debt deflation identified first by Irving Fisher in inevitably increases bankruptcy risk.
Third, consumers - expecting price declines to continue - delay purchases because the real value of cash is likely to be higher in the future. This reduces demand, pushing the economy further into depression.
Deflation can be prevented, but not by sticking to policy prescriptions designed for an inflationary era. In fact, many of the steps that were wrong for an inflationary era are the right thing to do now. Take the current UK debate on tax cuts, which many people say "we cannot afford". In an inflationary era, tax cuts should not be allowed to increase domestic demand; so they need to be financed by tax increases elsewhere, or by public spending cuts.Price inflation is regarded as a serious economic problem because it causes a number of significant costs to an economy, including the following: It erodes the value of money and assets A rise in the price level means, ceteris paribus, that money can buy fewer goods.
Deflation typically occurs in and after periods of economic crisis. When an economy experiences a severe recession or depression, economic output slows .
Inflation can be a problem when it is unexpected or very high, which can result in economic instability and people being afraid to spend money, which hinders economic growth. Furthermore, inflation can make products and services unaffordable to those on fixed-income.
Inflation can be a problem when it is unexpected or very high, which can result in economic instability and people being afraid to spend money, which hinders economic growth. Deflation is defined as a fall in the general price level. It is a negative rate of inflation.
It means the value of money increases rather than decreases. Deflation is not necessarily bad, but often periods of deflation / low inflation can lead to economic stagnation and periods of high.
Aug 02, · So the argument that deflation is a bad thing is also an argument saying that some economic problems get worse as inflation falls, and that too low an inflation rate may actually be economically damaging.