Small amounts of deflation are good
What is deflation?
deflation is a term from economics. It describes a generally falling price level over a longer period of time. Deflation, by definition, in short, is a state of the economy in which the Monetary value rises and prices fall.
However, not every fall in prices can be equated with a deflationary phase. Only the price declines that lead to unemployment, overproduction or declining economic activity are deflationary.
Falling employment, production and income accompany falling prices in this situation.
During deflation, it growsAmount of goods produced in an economy faster than the amount of money. This leads to a real appreciation of money that consumers can feel. Society can buy more goods and services with the same amount of money than it did before deflation. -The purchasing power is growing.
inflation is the opposite of deflation. Economists and central banks consider continuous slight inflation with correspondingly rising prices to be ideal for the development of an economy. Ideally, the inflation rate is two percent.
In the expectation of rising prices in the future invest Companies. At the same time, consumers consume as wages and salaries rise. Inflation is therefore generally accepted.
Causes and Types of Deflation
There are two different types of deflation: money supply and price deflation.
Money supply deflation
The money supply deflation describes a generally shrinking money supply in the economic cycle. A decreasing supply of money goes hand in hand with an undersupply of the economy with capital. The reason is often a restrictive reduction in the amount of money in circulation by central banks such as the FED in the USA or the ECBin Europe.
Other possible triggers for money supply deflation are Introducethat significantly exceed a country's exports. If more goods are imported than exported, considerable funds flow abroad. At the same time, the domestic money supply is decreasing.
Price deflation is characterized by the fact that theConsumer prices for goods and services are falling over a longer period of time are.
If this is the case, the demand for everyday products, material assets and services will decrease. Since market participants expect prices to continue falling, consumers are postponing their private purchases into the future and as a result Investmentsof companies. This can trigger a downward spiral in price development.
Effects of Deflation on the National Economy
Falling prices and increasing purchasing power appear to be very positive at first glance. Has a deflationary phaseHowever, the consequences for the economy as a whole are devastating. Hence the cost of deflation is indisputable. Consumption is falling due to the wait-and-see attitude of consumers in the hope of even lower prices.
This leads to a deflationary spiral:
Declining consumption is reflected in one thing for companies lower paragraph as well as reduced profits. At the same time, the costs of production usually remain fixed by means of contracts. Since the wages and salaries of employees are also contractually agreed, companies can not flexible react. An initial recession turns into deflation.
- Despite falling income, expenses remain constant.
Since most companies use the Personnel costs are the largest cost block, many companies initially do not fill any vacancies and instead introduce short-time work.
If sales and profits continue to fall during deflation, operational-related factors follow Terminations. At the same time, companies postpone investments in new machines or systems.
More unemployed mean less consumption. This leads to falling income tax revenues. At a rising unemployment the uncertainty among consumers is growing. These postpone or cancel completely larger purchases and expenses for products that are not absolutely necessary. This also includes vacations.
The Consumption continues to declinewhich in turn leads to the state losing out on sales tax revenues. If no suitable countermeasures are initiated in this phase,slides the deflationary phase into a depression and deep economic crisisfrom.
Actions to Combat Deflation
A shrinking economy is a serious oneThreat to the prosperity of a society. In a deflationary phase, the state can counteract the private decline in consumption through investments and prevent a crisis. For example, through new transport infrastructure such as the rail network or motorways. The government creates new jobs through such plants.
- Unemployment is falling, while consumption is rising.
ToFighting deflation Another government measure may include lowering taxes:
With a lower income tax, consumers have more money at their disposal, which is why the demand for goods and services can rise again.
The state can also lower corporate taxes. This creates incentives to invest more again and thus stimulates the labor market. This increases the value of money again.
The central banks can also use their monetary policy to help fight deflation. If the ECB cuts the key interest rate, loans for investments or larger purchases become more attractive. This includes, for example, investors investing in real estate or financing a new car. Increased demand for credit among businesses and consumers increases the amount of money in an economy. Deflation is then successfully combated.
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