Deflation stands for the decline in prices for services and goods that happens when the inflation rate becomes negative. This term means the opposite of inflation. Generally, deflation may occur naturally in case the money supply of a particular economy is fixed.
Deflation increases the value of the currency, which makes it possible for consumers to purchase more services and goods with the same amount of money.
Although it can be useful for shoppers, economists suggest that because deflation makes the real value of debt higher, it can be a great problem of the contemporary economy.
Deflation slows down the growth of the economy. Consumers tend to postpone purchases when the prices decrease. For instance, this works when you are thinking about buying a new TV, mobile phone, or iPad. Many people prefer to wait until the end of the year in order to have the opportunity to buy this year’s model much cheaper.
This situation makes the manufacturers constantly create new products and lower their prices. Such cost-cutting leads to fewer investments and lower wages for workers.
Types of Deflation
- Debt deflation was proposed in 1933 as the explanation of the deflation during the Great Depression.
- Money supply side deflation describes a perspective from which the main cause of deflation is a decrease in the velocity of money.
- Credit deflation may happen in the credit-based economy of today when the central bank initiates higher interest rates. It makes less economical for consumers, businesses, and governments to use debt financing. On the other hand, the economic power of savings-based equity financing gets higher under deflation.
There are three main reasons for deflation since 2000. Firstly, China sends export to other countries keeping the prices low. Secondly, modern technology keeps the productivity of the workers pretty high allowing to find the necessary information online in seconds. Lastly, many aging baby boomers continue working while having low wages because they can’t afford to retire. Thus, corporations and companies don’t feel the need to raise prices.