Tuesday, February 17, 2015

Negative Inflation


Negative_Inflation
Image credit: Sofia news agency
Inflation – Deflation 

Inflation is a term which tends to reduce the real value of money over time and deflation increases the real value of money, the currency of a regional or national economy, enabling an individual to purchase more products with the same amount of money overtime. In other words deflation is a situation when the price level decreases and the inflation rate tends to get negative.

Economist are of the opinion that deflation could be a problem in a modern economy since it increases the real value of debt and affects recessions, leading to a deflationary spiral. All episodes of deflations do not correspond with phases of poor economic growth. During the 19th century, deflation took place periodically in the U.S. and this deflation was the result of technological progress creating significant economic growth while at other times was due to financial crises particularly the Panic of 1837 that caused deflation during1844 as well as the Panic of 1873 triggering the Long Depression which lasted till 1879.

These periods of deflation were prior to the establishment of the U.S. Federal Reserve System and the active management of monetary issues. Deflation episodes were rare and brief with the development of Federal Reserve while American economic progress has been unprecedented

Negative Inflation 

Negative inflation is said to be an economic phenomenon wherein the economy tends to move out of an inflationary phase and enters into a phase where there is less money in circulation. Negative inflation tends to occur when the prices fall due to the supply of goods which is higher than the demand for those products.

It is often due to reduction in money, consumer or credit spending and could be the result of a combination of various factors which may include, having excess money in circulation that may decrease the value of money which in turn would reduce prices, with more products manufactured than the demand for the same.

 This could lead to businesses decreasing their prices in order to urge consumers to purchase those products and not having sufficient money in circulation causes those with money to hold on to it instead of spending it and decreased demand for goods decreases spending.

Though it would seem that lower prices are good, deflation could ripple through the economy for instance when it creates high level of unemployment, turning into a bad situation and this type of a recession could turn into a worse situation like a depression.

Leads to Unemployment => Decrease in Spending => Less Demand

Deflation could lead to unemployment since the companies tend to make less money and react on cutting costs to survive which may include in closing of the stores, plants and warehouses and laying-off their workers.

This results in the worker having to decrease on their spending leading to less demand with more deflation causing a deflation spiral which may be difficult to break. Deflation tends to work without affecting the rest of the economy when businesses are capable of cutting the costs of production for the purpose of lowering prices like in the case of technology, since the cost of technology products has reduced over the years though it was due to the cost of producing technology that had decreased and not due to decreased demand.

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