But that's not correct. The reduced consumption by households as their loan payments rise isn't matched by a corresponding increase in consumption by lenders who are generally wealthy and tend to save the extra income.
Thus, overall spending falls. That depresses demand further, prices fall more and the result is Fisher's debt-deflation spiral. The third problem with deflation is that wages and prices are generally sticky. That is, they don't adjust as quickly as needed to keep supply and demand balanced. Wages tend to be particularly sticky in the downward direction. The problem is that when prices are falling but wages aren't, it increases the inflation-adjusted cost of labor, and that leads to unemployment.
The rise in unemployment leads to less spending, and that causes prices to fall further. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield — Japanese bank deposits are a really good deal compared with those in America — and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed.
And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.
There was much concern about deflation in the U. Commodity prices fell, and debtors found it harder to repay loans. The stock market was down, unemployment was up, and home prices dropped precipitously.
One study published in the American Journal of Macroeconomics suggests that the financial crisis at the beginning of the period managed to prop up inflation. While a slight decrease in prices may spur consumer spending, broad deflation can discourage spending and lead to even greater deflation and economic downturns. I'm a freelance journalist, content creator and regular contributor to Forbes and Monster. Find me at kateashford. John Schmidt is the Assistant Assigning Editor for investing and retirement.
Before joining Forbes Advisor, John was a senior writer at Acorns and editor at market research group Corporate Insight. Select Region. United States.
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Deflation Definition Deflation is when consumer and asset prices decrease over time, and purchasing power increases. How Is Deflation Measured? Deflation vs. Disinflation Deflation is not to be confused with disinflation. What Causes Deflation? A drop in aggregate demand may be triggered by: Monetary policy: Rising interest rates may lead people to save their cash instead of spending it and may discourage borrowing. Less spending means less demand for goods and services.
Declining confidence: Adverse economic events—such as a global pandemic—may lead to a decrease in overall demand. If people are worried about the economy or unemployment, they may spend less so they can save more. Consequences of Deflation Although it may seem helpful for the price of goods and services to fall, it can have very negative effects on the economy. As prices drop, company profits decrease, and some companies may cut costs by laying off workers.
Interest rates tend to go up in periods of deflation, which makes debt more expensive. Consumers and businesses often decrease spending as a result. Deflationary spiral. Governments can be caught in the same trap, because if prices and incomes fall, so does tax revenue. And to state the obvious, there is an awful lot of debt floating around the eurozone - money owed by governments, households and banks.
Deflation could aggravate that problem. In the case of the eurozone, those countries experiencing very low inflation - or actual deflation, as a few are including Greece - tend to be those with relatively high levels of private or public debt. There is, however, some comfort to be had from that.
Those with debt problems also tend to be those that have seen their competitiveness decline. Falling or barely rising prices and incomes do help address that. Another issue is the effectiveness of central bank policy at a time of economic weakness. The key point here is the level of central banks' real interest rates: that is, after subtracting inflation.
There have been many episodes in the past when real rates have been below zero. That is impossible to do when there's deflation, as you can't get interest rates much below zero. So it makes it much harder for the central bank to do anything to stimulate a flagging economy. Then there is the incentive to delay spending that can come with deflation. If something will be cheaper next year, some people might delay buying it. It doesn't apply to everyday essential purchases; you cannot wait 12 months for lunch.
But it can be relevant to items where there is more room for delay - are you going to replace that fridge now or next year?
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