Deflation , in economic terms, is the sustained and widespread fall in the prices of goods and services over a certain period of time (at least two semesters according to the IMF ). It is the opposite of inflation . Deflation can be caused by various reasons and can have more serious consequences than inflation.
Summary
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- 1 Causes of deflation
- 1 Insufficient demand
- 2 Over supply
- 2 Effects of deflation
- 3 Measures against deflation
- 4 Sources
Deflation causes
Deflation is caused by a drop in personal spending, a drop in government spending, or a drop in investment, leading to an imbalance between supply and demand in which demand always remains below supply.
Insufficient demand
The best example of deflation due to falling demand is the Great Depression that took place in the United States and during which the CPI fell 24% in the period 1929 – 1933 . The cause was the drastic reduction in the purchasing power of American families after the collapse and collapse of the financial system.
Excessive supply
An excess of supply comes from an excess of production and the productive capacity of the companies without this materializing in the fulfillment of the expectations that led to the rise in production and it can also be produced by greater competition. These events usually come in expansionary cycles of the economy during which the consumer has greater spending power. For example, the liberalization of basic sectors of the economy such as transport, energy or communications, as well as increasingly global free trade plans, which occurred generally in industrialized countries during the 1990s led to to an increase in competition between companies that led to a sustained increase in the supply of companies in these sectors.
Effects of deflation
Deflation, beyond the practical drop in prices, generates negative effects on the economy that often enter a vicious circle of deceleration effects. For example, let’s take the case that consumer spending power falls, leading to a drop in demand. The products begin to drop in price in an attempt to release the stock. As this cycle unfolds, consumers continue to spend less, leading to further price drops in a more desperate attempt by merchants to exit the stock and at least cover business expenses. Consumers will further lower demand by understanding that prices continue to drop and they will be able to get the same product at a lower price in the near future. With this developing circle, less and less money circulates with the consequent negative effects: prolonged deflation is unsustainable and very difficult to correct. Companies begin to have losses by not being able to give out the products and having to face the same fixed expenses with lower incomes, this will lead to cutbacks in the labor force, increasing unemployment, which will fuel deflation. To all this is added an increase in the interest that the debtors have to face. Although interest rates do not vary, the drop in prices increases the debt of a credit proportionally.
Measures against deflation
The governments and economic authorities of the country that is immersed in a circle of deflation tend to put in place policies and measures aimed at increasing demand to try to match supply. However, most economists and experts agree that deflation prevention measures are the ones that a government should focus on, since once a deflation process is in place, correcting it is very difficult. Monetary policy measures: The most common proposal against deflation by the monetary authorities is the lowering of interest rates. With this measure, it is sought that banks and financial institutions have funds more easily so that credit to families is encouraged to increase spending. Government measures: Among the measures against deflation that can be taken by administrations and governments, it is worth highlighting the increase in public spending to put money into motion and boost the economy. Normally, the measures taken consist of a combination of both, facilitating credit and increasing public spending.
