Since we made our way out of the 2007-2009 Great Recession, the term inflation has most often been bandied around in articles, newscasts and think pieces, while the term deflation has been somewhat left out. However, as the economy looks set to make a turn for the worse and begin a descent into yet another recession, deflation is suddenly a growing concern.
Everyone is impacted during times of economic deflation, so it is important to know exactly what you are facing and what you can do to protect yourself and your personal finances. If you are not exactly sure what deflation is and what causes it, keep reading to learn more about one of the most important issues the global economy is facing today.
What deflation is and how to spot it
There are a number of different ways to answer the question of what is deflation but perhaps it is easier to start with what inflation is. Inflation is a general increase in the price levels of goods and services; the result of this increase in price is that consumers buy fewer goods and services because everyone’s purchasing power has been reduced.
Deflation, on the other hand, is what happens when purchasing power increases because the price of goods and services has generally decreased. This may seem like a good thing (who doesn’t like being able to buy more for less?) but it can actually be more detrimental than inflation.
Deflation is ultimately bad for the economy because when prices start to decline, consumers decrease their spending levels on the assumption that the prices will continue to reduce. Lower spending levels leads to lower profits for producers, which in turn results in unemployment. These three factors – lower spending, lower profits, growing unemployment – create a feedback loop and can develop into a downward spiral.
The causes of deflation
To put it simply, there are essentially two main causes of deflation – a surge in supply or a decrease in demand, both of which are linked to the economic relationship between supply and demand. The reduction of demand could be brought about by a number of factors, including fiscal policy and diminishing confidence in the economy.
Regarding fiscal policy, if the Federal Reserve does not curb interest rates, an increase in interest rates can result in consumers saving their money instead of investing, borrowing or spending it. A reduction in spending kicks off the cycle of a reduction in profits for producers and a corresponding rise in unemployment.
Also, if consumers are starting to lose faith in the economy itself, there will likely be a reduction in demand. Think about it – when the economy looks like it could take a nose dive, are you really going to want to take out a big loan and buy a house? Or would you prefer to ride out the recession wave in a rented apartment that you could give up at any time?
If you are concerned about the state of the economy and potential job loss, you are more likely to curb your spending, dig in to save money, and put off big investments.
Re-inflating to avoid deflation
Thankfully, there are a number of different ways to re-inflate a deflating economy. Just as fiscal policy can create deflation, it can also drag us out of it. If the Federal Reserve changes policy to lower interest rates or cuts taxes for the 99%, consumers are more likely to spend and borrow than they otherwise would be. The Federal Reserve can also increase the supply of money and thereby slowly reduce the value of every dollar, thus making it easier for consumers to spend money.
Global trends, global economics
Now, more than ever before, national economies are deeply influenced by global economic trends and factors. Large countries with dominant economies, such as the United States, China and India, have more of an ability to sway the global economy than smaller countries, but in an increasingly globalized marketplace, smaller markets are gaining more and more attention.
Over the next few years, countries around the world are likely to start introducing new fiscal policies in an attempt to curb deflation. It will be interesting to watch as various financial strategies and national plans interact and influence one another. Now that you understand deflation, you too can enjoy watching the changes that the next decade will bring.
