Deflation

Question 1

What is deflation

Answer 1

A persistent fall in a country’s general price level

Question 2

Demand side causes of deflation

Answer 2

• deep fall in AD causing a persistent recession / depression
• large negative output gap - i.e. high level of spare capacity

Question 3

Supply-side causes of deflation

Answer 3

• improved productivity
• technological advances
• fall in wage rates
• high XR (causing import prices to fall)

Question 4

Consequences of price deflation

Answer 4

• holding back on spending
• debts increase
• real cost of borrowing increases
• lower profit margins
• confidence and saving
• income distribution
• exports more competitive eventually

Question 5

Main approach to avoiding deflation

Answer 5

To use macro-stimulus policies either by loosening monetary policy (cutting interest rates) and / or fiscal policy (to increase domestic demand for goods and services)

Question 6

Economic policies to avoid price deflation

Answer 6

• low interest rates and quantitative easing
• fiscal stimulus measures
• attempts to lower the XR
• higher taxes on savings to encourage consumption