TEMPO.CO, Jakarta – Deflation, according to the Cambridge dictionary, is a reduction of the supply of money in an economy, and therefore a reduction of economic activity, that is often part of an intentional government plan to reduce prices.
Like any other economic term, deflation covers a large area of issues under the roof of the economy, especially from a money point of view.
This article introduces the meaning of deflation, including its causes and effects, as cited by various economic sources.
What Is Deflation?
Deflation is a decrease in the base price level of both goods and services in a country. The meaning of deflation is opposite to that of inflation. Many economists consider deflation as the negative inflation.
Adequate fall in the price of certain goods like food can give positive light though some experts argue that deflation creates negative trends in the economy. It creates a rampant opportunity for consumers to spend more on basic products, which uplifts the economic growth of the country. As a result, countries hit by deflation accord some room for the value of the currency to grow.
Deflation worsens the economy when debt deflation occurs. Debt deflation occurs when the interest rate on financial debt rises. This process poses a threat of crisis in the economy.
Deflation is considered a better economic activity when complemented by positive factors such as technological improvements in reducing the cost of general prices. Meanwhile, a lack of demand in the market makes deflation worse than inflation.
What Causes Deflation?
In general, the decline in aggregate demand and the increase in supply are the two prominent causes of deflation. The decrease in demand leads to a decrease in the prices of goods and services in general.
Although the prices of goods are cheaper, some countries see a decline in the money supply. When deflation occurs, there is a tendency for savings money to circulate. This economic activity leads to higher interest rates on financial debt.
Among other problems that arise during the decrease in supply is lower production costs. Companies may produce more goods which leads to oversupply problems. Failure to create sales based on the available products will cause companies to make their goods cheaper.
Technological advancement is also seen as a growing problem due to its effect on lowering prices. Oversupply is often seen as a negative trend in the economy.
The Effects of Deflation
One of the most noticeable effects of deflation is oversupply. The unemployment rate usually skyrockets because of this problem. Companies tend to adjust their costs through massive layoffs. Many other financial areas such as the value of debt and consumer behavior are affected by deflation.
Investors are advised to buy both investment and dividend stocks and to keep money in cash to avoid deflationary spirals where falling prices create more economic problems.
In conclusion, moderate deflation means that the economy is growing. Otherwise, there is a risk of recession.
Investopedia
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