Deflation Flashcards
What is deflation?
Deflation is also known as negative inflation and happens when prices generally fall in an economy.
When does deflation occur?
Deflation occurs when the rate of inflation falls below 0%, resulting in a negative inflation rate.
What factors can cause deflation?
Deflation can be caused by either demand-side factors or supply-side factors in the economy.
How does demand-side deflation occur?
Demand-side deflation is most likely to occur during a recession when unemployment is high and incomes are falling.
What is the effect of decreased consumer spending on prices?
Decreased consumer spending and business investment cause aggregate demand to fall, putting downward pressure on prices.
What causes supply-side deflation?
Supply-side deflation can result from a decrease in costs of production.
Give an example of a supply-side deflation.
The decrease in the price of a barrel of oil from $110 in 2014 to $60 in 2015 reduced costs for producers, leading to cheaper prices for goods like food.
This is an example of a positive supply shock.
What are the benefits of an increase in aggregate supply?
An increase in aggregate supply lowers the general price level, results in lower unemployment, and promotes higher economic growth.
Is deflation from increased aggregate supply a concern for governments?
Deflation resulting from an increase in aggregate supply is unlikely to be a concern for a government.
What is the impact of deflation from falling aggregate demand?
Deflation from falling aggregate demand can be highly damaging to an economy over time and can be very difficult to recover from.
What are the causes of a fall in aggregate demand?
- Fall in the money supply
- Decline in confidence
- A higher exchange rate
How does a fall in the money supply affect spending?
A tighter monetary policy increases interest rates, leading people to save more and spend less.
What effect does a decline in confidence have on consumer behavior?
Consumers may prefer to increase savings and reduce current spending during negative economic events.
What is the impact of a higher exchange rate on exports?
Exports become more expensive for foreign consumers, leading to a smaller quantity purchased.
What is the impact of a higher exchange rate on imports?
Imports become cheaper for domestic consumers, leading to a larger quantity purchased.
What is a beneficial consequence of deflation resulting from decreasing costs of production?
It can make domestic firms more competitive, leading to an increase in sales of exports abroad.
How does deflation affect consumer behavior regarding imports?
Consumers are likely to purchase fewer imports and choose locally produced goods at relatively cheaper prices.
What impact does deflation have on consumers’ purchasing power?
Consumers experience an increase in their purchasing power, enabling them to increase consumption and improve their standards of living.
What is a potential outcome of higher demand for products due to deflation?
Firms are likely to expand production, leading to increased employment and stronger economic growth.
What is a serious problem for an economy caused by deflation?
Deflation resulting from a fall in aggregate demand can be a serious problem.
How might consumers react if they expect future prices to be cheaper?
They may choose to delay their consumption of some goods and services until a future date.
What is the effect of delayed consumer spending on the economy?
It results in a fall in aggregate demand, leading to an increase in unemployment and worsening deflation.
What is the likely impact of deflation caused by falling aggregate demand on workers?
Unemployment is likely to be high and job security for many workers is likely to be low.
How might workers respond to uncertainty during deflation?
Many workers may choose to save a higher proportion of their income.
What is the consequence of reduced consumer spending due to workers saving more?
It may lead to a further reduction in aggregate demand, worsening unemployment and deflation.
What is the effect of deflation on savers?
Deflation provides an incentive to save as the real value of money held in bank accounts will increase over time.
How does deflation affect spending behavior?
Individuals and firms may save more and spend less in deflationary periods.
What are the consequences of reduced consumption during deflation?
This results in higher unemployment, falling economic growth, and worsening deflation.
How do lenders benefit from deflation?
Lenders are likely to gain from deflation as the money they lend out today will buy more goods and services when it is repaid in the future.
What is the impact of deflation on borrowers?
Deflation provides a disincentive to borrow as money borrowed today will be worth more when it has to be repaid in the future.
What is the effect of reduced borrowing during deflation?
Individuals and firms are likely to reduce borrowing, resulting in reduced consumer spending and business investment in the economy.
What happens to existing debt if falling prices persist?
Existing debt will increase in real terms and become harder for households, firms, and the government to repay.
How does deflation affect firms’ cash holdings?
Deflation provides an incentive for firms to increase their cash holdings when prices are falling as the value of cash increases over time.
What is the investment behavior of firms during deflation?
Firms tend to hold large sums of cash rather than invest it in the purchase of capital equipment and machinery, which is more risky.
What is the overall effect of reduced investment during deflation?
The resulting reduction in investment leads to a further decrease in aggregate demand in the economy, worsening unemployment and deflation.
What is the effect of deflation on savers?
Deflation provides an incentive to save as the real value of money held in bank accounts will increase over time.
How does deflation affect spending behavior?
Individuals and firms may save more and spend less in deflationary periods.
What are the consequences of reduced consumption during deflation?
This results in higher unemployment, falling economic growth, and worsening deflation.
How do lenders benefit from deflation?
Lenders are likely to gain from deflation as the money they lend out today will buy more goods and services when it is repaid in the future.
What is the impact of deflation on borrowers?
Deflation provides a disincentive to borrow as money borrowed today will be worth more when it has to be repaid in the future.
What is the effect of reduced borrowing during deflation?
Individuals and firms are likely to reduce borrowing, resulting in reduced consumer spending and business investment in the economy.
What happens to existing debt if falling prices persist?
Existing debt will increase in real terms and become harder for households, firms, and the government to repay.
How does deflation affect firms’ cash holdings?
Deflation provides an incentive for firms to increase their cash holdings when prices are falling as the value of cash increases over time.
What is the investment behavior of firms during deflation?
Firms tend to hold large sums of cash rather than invest it in the purchase of capital equipment and machinery, which is more risky.
What is the overall effect of reduced investment during deflation?
The resulting reduction in investment leads to a further decrease in aggregate demand in the economy, worsening unemployment and deflation.
