Deflation is a decline in the general price level of goods and services, often seen as an economic problem that can worsen recessions. It typically arises from a fall in aggregate demand or an increase in aggregate supply, leading to increased unemployment and a rise in the real value of debt. Counteracting deflation involves using macro-stimulus policies such as monetary easing and fiscal measures to boost demand.

1. Deflation
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2. WHAT IS DEFLATION?
• DEFLATION IS A DECREASE IN THE GENERAL PRICE LEVEL OF GOODS AND
SERVICES. PUT ANOTHER WAY, DEFLATION IS NEGATIVE INFLATION.
WHEN IT OCCURS, THE VALUE OF CURRENCY GROWS OVER TIME. THUS,
MORE GOODS AND SERVICES CAN BE PURCHASED FOR THE SAME AMOUNT
OF MONEY.
• DEFLATION IS WIDELY REGARDED AS AN ECONOMIC “PROBLEM” THAT CAN
INTENSIFY A RECESSION OR LEAD TO A DEFLATIONARY SPIRAL.

3. COUNTRIES WITH THE LOWEST INFLATION
RATE IN 2015

4. CAUSES OF DEFLATION
• ECONOMISTS DETERMINE THE TWO
MAJOR CAUSES OF DEFLATION IN AN
ECONOMY AS
(1) FALL IN AGGREGATE DEMAND AND
(2) INCREASE IN AGGREGATE SUPPLY.

5. FALL IN THE MONEY SUPPLY
• A CENTRAL BANK MAY USE A TIGHTER MONETARY POLICY BY
INCREASING INTEREST RATES. THUS, PEOPLE, INSTEAD OF SPENDING
THEIR MONEY IMMEDIATELY, PREFER TO SAVE MORE OF IT. IN ADDITION,
INCREASING INTEREST RATES LEAD TO HIGHER BORROWING COSTS,
WHICH ALSO DISCOURAGES SPENDING IN THE ECONOMY.

6. DECLINE IN CONFIDENCE
• NEGATIVE EVENTS IN THE ECONOMY, SUCH AS RECESSION, MAY ALSO
CAUSE A FALL IN AGGREGATE DEMAND. FOR EXAMPLE, DURING A
RECESSION, PEOPLE CAN BECOME MORE PESSIMISTIC ABOUT THE FUTURE
OF THE ECONOMY. SUBSEQUENTLY, THEY PREFER TO INCREASE THEIR
SAVINGS AND REDUCE CURRENT SPENDING.

7. LOWER PRODUCTION COSTS
• A DECLINE IN PRICE FOR KEY PRODUCTION INPUTS (E.G., OIL) WILL LOWER
PRODUCTION COSTS. PRODUCERS WILL BE ABLE TO INCREASE PRODUCTION
OUTPUT, WHICH WILL LEAD TO AN OVERSUPPLY IN THE ECONOMY. IF
DEMAND REMAINS UNCHANGED, PRODUCERS WILL NEED TO LOWER THEIR
PRICES ON GOODS TO KEEP PEOPLE BUYING THEM

8. TECHNOLOGICAL ADVANCES
• ADVANCES IN TECHNOLOGY OR RAPID APPLICATION OF NEW
TECHNOLOGIES IN PRODUCTION CAN CAUSE AN INCREASE IN AGGREGATE
SUPPLY. TECHNOLOGICAL ADVANCES WILL ALLOW PRODUCERS TO LOWER
COSTS. THUS, THE PRICES OF PRODUCTS WILL LIKELY GO DOWN.

9. EFFECTS OF DEFLATION
• FREQUENTLY, DEFLATION OCCURS DURING RECESSIONS. IT IS CONSIDERED AN
ADVERSE ECONOMIC EVENT AND CAN CAUSE MANY NEGATIVE EFFECTS ON THE
ECONOMY, INCLUDING:

10. INCREASE IN UNEMPLOYMENT
• DURING DEFLATION, THE UNEMPLOYMENT RATE WILL RISE. SINCE PRICE
LEVELS ARE DECREASING, PRODUCERS TEND TO CUT THEIR COSTS BY
LAYING OFF THEIR EMPLOYEES.

11. INCREASE IN THE REAL VALUE OF DEBT
• DEFLATION IS ASSOCIATED WITH AN INCREASE IN INTEREST RATES,
WHICH WILL CAUSE AN INCREASE IN THE REAL VALUE OF DEBT. AS A
RESULT, CONSUMERS ARE LIKELY TO DEFER THEIR SPENDING

12. THE REAL COST OF BORROWING
INCREASES
• REAL INTEREST RATES WILL RISE IF NOMINAL RATES OF INTEREST DO
NOT FALL IN LINE WITH PRICES.

13. LOWER PROFIT MARGINS
• LOWER PRICES CAN MEAN REDUCED REVENUES & PROFITS FOR BUSINESSES
- THIS CAN THEN LEAD TO HIGHER UNEMPLOYMENT AS FIRMS SEEK TO
REDUCE COSTS BY SHEDDING LABOUR.

14. EXPORTERS MORE COMPETITIVE
• DEFLATION CAN MAKE EXPORTERS MORE COMPETITIVE EVENTUALLY – BUT
THIS OFTEN COMES AT A COST I.E. HIGHER UNEMPLOYMENT IN SHORT
TERM

15. HOW DOES ONE COUNTERACT AGAINST
DEFLATION?
• UNTIL THE 1930S, IT WAS COMMONLY BELIEVED BY ECONOMISTS THAT
DEFLATION WOULD CURE ITSELF. •
• AS PRICES DECREASED, DEMAND WOULD NATURALLY INCREASE AND THE
ECONOMIC SYSTEM WOULD CORRECT ITSELF WITHOUT OUTSIDE
INTERVENTION.
• THIS VIEW WAS CHALLENGED IN THE 1930S DURING THE GREAT DEPRESSION
BY THE ECONOMIST KEYNES WHO ARGUED THAT THE ECONOMIC SYSTEM WAS
NOT SELF-CORRECTING WITH RESPECT TO DEFLATION.

16. WHAT DID KEYNES SAY?
• ACCORDING TO HIM, GOVERNMENTS AND CENTRAL BANKS HAD TO TAKE
ACTIVE MEASURES TO BOOST DEMAND THROUGH TAX CUTS OR INCREASES
IN GOVT. SPENDING.
• TODAY, TO COUNTER DEFLATION, THE RESERVE BANK OF INDIA (RBI) CAN
USE MONETARY POLICY TO INCREASE THE MONEY SUPPLY AND
DELIBERATELY INDUCE PRICE RISE.
• RISING PRICES PROVIDE AN ESSENTIAL LUBRICANT FOR ANY SUSTAINED
RECOVERY BECAUSE BUSINESSES INCREASE PROFITS AND THIS TAKES
SOME OF THE DEPRESSIVE PRESSURES OFF THEM.

17. ECONOMIC POLICIES TO AVOID PRICE
DEFLATION
• THE MAIN APPROACH TO AVOIDING DEFLATION IS TO USE MACRO-STIMULUS POLICIES
EITHER BY LOOSENING MONETARY POLICY AND/OR FISCAL POLICY
• LOW INTEREST RATES AND QUANTITATIVE EASING
• IN SOME COUNTRIES, POLICY INTEREST RATES HAVE BECOME NEGATIVE E.G.
SWITZERLAND
• CHEAPER LOANS FOR BUSINESSES AND HOUSEHOLDS
• EXPANDING THE SUPPLY OF CREDIT IN BANKING SYSTEM
• QE USED BY MANY CENTRAL BANKS INCLUDING BOE AND EUROPEAN BANK

18. FISCAL STIMULUS MEASURES
• HIGHER GOVERNMENT SPENDING (E.G. CAPITAL PROJECTS)
• A RISE IN GOVERNMENT BORROWING TO INJECT DEMAND INTO THE
CIRCULAR FLOW
• LOWER DIRECT TAXES TO INCREASE DISPOSABLE INCOME AND SPENDING

19. OTHER MEASURES TO STIMULATE
AGGREGATE DEMAND
• ATTEMPTS TO LOWER THE VALUE OF THE EXCHANGE RATE (PERHAPS VIA
CENTRAL BANK INTERVENTION TO SELL THEIR CURRENCY IN THE MARKET)
• HIGHER TAXES ON SAVINGS TO ENCOURAGE CONSUMPTION

20. TO SUM UP
• WHAT: DEFLATION IS A SUSTAINED DECREASE IN THE GENERAL PRICE
LEVEL OF GOODS AND SERVICES.
• HOW: DEFLATION OCCURS WHEN THE ANNUAL INFLATION RATE FALLS
BELOW ZERO PERCENT AND PRICES CONTINUE TO FALL ON A SUSTAINED
BASIS
• WHY: DEFLATION IS CAUSED BY A SHIFT IN THE SUPPLY AND DEMAND
CURVE FOR GOODS AND INTEREST, PARTICULARLY A FALL IN THE
AGGREGATE LEVEL OF DEMAND.