macro 25 inflation and deflation

Question 1

define deflation?

Answer 1

sustained decrease in the average price level in an economy.

Question 2

What are the 2 main causes of deflation?

Answer 2

1. Recession (malign) - fall in AD.
2. Increase in productive potential (benign)

Question 3

what is aggregate supply usually accompanied by when its increasing?

Answer 3

1. Privatisation.
2. Deregulation.
3. Reduction in union power.
4. Flexible labour markets.

Question 4

Explain “Deflationary spiral” as a consequence of deflation?

Answer 4

People wait for prices to drop further. Eg: japan in the 2000’s.

EVAL:
- Central banks can control this by decreasing interest rates provided there is no liquidity trap.
- deflation is not a problem is AD is not falling by a significant amount.
- Inflation is the most important target so deflation is not considered a problem.

Question 5

Explain “fall in investment” as a consequence of deflation?

Answer 5

Animal spirits will be low because firms anticipate less AD in the future as consumption is low. This means that firms can work with the spare capacity and dont need to increase the productive potential.

EVAL:
- Fall in COp may lead to more investment.
- Investment is dependant on other things such as Interest rates, which are likely to drop in a recession.

Question 6

Explain “impact on real interest rates” as a consequence of deflation?

Answer 6

Real interest rates will increase.
Real IR = IR - Inflation.
A rise in RIR decreases consumption.

EVAL:
- Consumption is affected by other things.

Question 7

Explain “impact on debt” as a consequence of deflation?

Answer 7

Definition rises the real value of debt, making the default more likely.

EVAL:
- For this to happen, deflation has to be significant and needs to be sustained over a long period of time.

Question 8

What are some benefits on deflation?

Answer 8

• COP’s fall.
• Exports will increase.