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deflation

Page history last edited by Brian D Butler 9 years, 12 months ago

Why is Deflation bad?

 

problem:  deflation is terrible for a country...because it leads consumers to postpone consumption while they they expect prices to fall further, thus triggering a long slump

 

terrible for borrowers....who have to pay back loans with future dollars that are worth less.

 

Negative inflation can keep the real interest rate high enough to restrict economic growth.

 

Why is deflation so bad?

 

Deflation, or sustained declines in consumer prices, could further damage the economy by making debts more expensive to pay off and banks less willing to lend. 

 

 

How to measure deflation / inflation?

 

The Fed’s preferred benchmark, the personal consumption expenditures price index, excluding food and energy, may rise just 0.78 percent this year, according to Macroeconomic Advisers LLC in St. Louis. That is about 1 point below the preference range that policy makers signaled in their third-year forecasts in January 2008.

 

see more in our page on inflation

 

 

 

 

Problem with Deflation:

deflation appeared to add to the  problems, not least by raising the real value of household and company debts

 

 

Was Deflation a threat in 2008-10?

 

12/2008: "Deflation still hangs like a low, dark cloud over our sinking economy. Too few dollars are chasing too many goods, and this will worsen as unemployment hits 9% or more sometime next year. People fearful of losing their jobs are hoarding cash. Banks have become careful, stingy lenders. The danger is that, despite all the government stimulus, demand will stay weak.  source:  Barrons online

 

see also:  deleverage

 

 

2002 speech from Bernanke on deflation:

http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm

 

 

Wikipedia definition:

 

http://en.wikipedia.org/wiki/Deflation_(economics)

 

Deflation in economics is a persistent decrease in the general price level[1] of goods and services. Alternatively, the term was used by the classical economists to refer to a decrease in the money supply and credit; some economists, including many Austrian school economists, still use the word in this sense. The two meanings are closely related, since a decrease in the money supply is likely to cause a decrease in the price level.

Deflation is considered a problem in a modern economy because of the potential of a deflationary spiral and its association with the Great Depression, although not all episodes of deflation correspond to periods of poor economic growth historically.

 

risk adjusted return of assets drops to negative, investors and buyers will hoard currency rather than invest it, even in the most solid of securities. This can produce the theoretical condition, much debated as to its practical possibility, of a liquidity trap. A central bank cannot, normally, charge negative interest for money, and even charging zero interest often produces less stimulative effect than slightly higher rates of interest. In a closed economy, this is because charging zero interest also means having zero return on government securities, or even negative return on short maturities. In an open economy it creates a carry trade, and devalues the currency producing higher prices for imports without necessarily stimulating exports to a like degree.

 

Deflation is generally regarded negatively, as it is a tax on borrowers and on holders of illiquid assets, which accrues to the benefit of savers and of holders of liquid assets and currency. In this sense it is the opposite of inflation (or in the extreme, hyperinflation), which is a tax on currency holders and lenders (savers) in favor of borrowers and short term consumption. In modern economies, deflation is caused by a collapse in demand (usually brought on by high interest rates), and is associated with recession and (more rarely) long term economic depressions.

 

 

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