Deflation changes the value of money – it increases it.
The spending power of USD$100 is all the goods and services that can be bought with that USD$100. But, the spending power of money changes over time. If USD$100 buys more products this year than it did last year, then the value of money has increased. And this was caused by deflation.
What is deflation?
Deflation is the trend of decreasing prices of the products in the economy. Deflation occurs when there is continual fall in the average prices of goods and services over a period of time. During the times of deflation, prices in a country will have the persistent tendency to decrease.
Inflation and deflation are pretty much the opposites. Inflation is an increase in prices sustained over several periods while deflation is a decrease in prices.
What causes deflation?
With banks printing money out of thin air that do not match the real value of goods and services that are produced in the country, there might be loss of confidence in the unsustainable galloping economic growth that has been created.
At some point in the future, central banks will increase interest rates to slow down economic growth and high inflation. Due to lower money supply and people hoarding cash during tough times, demand from customers and businesses will decrease causing economic slowdown. The supply of products surpassing lower demand will cause depression in the economy as supply will be higher than demand.
The reduction in consumer spending will eventually lead to heavy price reductions, job losses as a result of cost cutting and even company failures.
Examples of deflation
Deflation results in a rise in the value of money, making people to afford more products for the same amount as before.
Example 1: In the US, during Great Depression of 1933 real estate prices and the stock market dropped by more than 85%. It was the result of the stock market crash that had begun in 1929.
Example 2: Japan battled mild deflation throughout the 2000s after a troublesome 1990s when the housing bubble burst and banking crisis happened.
Example 3: During the Great Recession in the US. that lasted between 2007 and 2009, the fall in house prices was one of the factors leading to recession.
Example 4: In October, 2013, inflation in the European Union fell to 0.8% causing real fear of deflation in countries that use the Euro common currency as reported by European Central Bank.
Example 5: In April 2020, China experienced factory deflation reporting falling Producer Price Index by 3.1% comparing to figures in April 2019. It was mainly caused by weak demand from customers and declines in oil prices.
While very high inflation is not good for the country, is deflation beneficial then for individual customers and businesses?
