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Understanding Deflation and the countries facing it

 

DEFINITION

Deflation is the opposite of inflation. During inflation, there is a sustained increase in prices of essential items and services over a period of time. In Deflation, there is a sustained decrease in prices of essential items and services over a period of time.

Deflation represents a situation where the spending capacity of the currency is greater than during normal circumstances. This term differs slightly from price deflation which represents a dip in price levels on the whole although these terms are sometimes used interchangeably and would need some clarification.

 

DEFLATION: A DEEPER LOOK

The effects of deflation could include a wide array of changes including depreciating capital, labour, goods and services which would not have been the case had the supply of money not been reduced. This could result in a lot of unprecedented situations like weakening of the economy, reduction in imports, trade imbalance among other unexpected results.

 

FACTORS BEHIND DEFLATION                                                                           

By definition, monetary deflation can only be caused by a decrease in the supply of money or financial instruments redeemable in money. In modern times, the money supply is mostly influenced by central banks, such as the Federal Reserve.

Periods of deflation most commonly occur after long periods of artificial monetary expansion.

There are two principle causes of price deflation: The primary reason can be attributed to an increased need for cash savings by retailers and the end customers as well. There may be different reasons attributed to this behaviour, namely due to their ambiguity in taking certain decisions, or maybe as a result of lengthening of time preferences for consumption. The second reason can be attributed to an increase in the overall economic efficiency which increases the supply of commodities and provides an impetus to the buying capacities of the masses.

Price deflation has different effects in different strata of the economy. Consider the Information and technology sector, which in 1980 had a quoting price for a gigabyte of memory at an astonishing rate of $435,000 which would match the price of modern supercars like Ferrari, Lamborghini, Maserati, Rolls-Royce and Bentley to name a few. Fast forward to 2017, and the same amount of technology costs a measly 3 cents which would not be enough to even purchase a chocolate! Therefore, this decline in the costs of advanced technology greatly increases the standard of living of the general population.

 

Also Read:

3 key points to understand negative interest rates

 

COUNTRIES EXPERIENCING DEFLATION

Most of the countries expected to experience deflation find themselves in the European region. Falling prices have been a constant trait in countries like Bulgaria, Croatia, Greece, Poland, Sweden and Spain. While Estonia, Germany and Thailand may not experience deflation on a quarterly or yearly basis, they are expected to see price drops in the months to come.

For some countries, deflation would be a short-term aspect rather than something expected to last many years. Few countries in this list include Italy, the United States, where an average drop of about 0.5 percent in prices is to be expected. Concluding the list would be countries like Switzerland and Bulgaria where declining prices seem to be the order of the day which, according to analysts at Deutsche Bank suggest a 1.5 percent decline in prices much to the delight of Swiss consumers.

  

DIFFERENT VIEWS ON IMPACT OF DEFLATION

In the aftermath of the Great Depression, where deflation in monetary aspects, a lack of jobs and loan defaults coincided, many analysts were of the belief that deflation was an adverse phenomenon after which banks changed their policies to encourage a uniform and equal increase in supply of money and this led to a promotion in severe price inflation and coaxed people into borrowing too many loans.

When the deflation history of 17 countries ranging over 180 years was taken into consideration, analysts like Andrew Atkeson and Patrick Kehoe were of the opinion that 65 out of a total of 73 deflation episodes had no impact on the economy while 21 out of 29 depreciations were not followed up by deflation of any kind. A debate now exists between the uses and applications of deflation and price deflation.

Deflation is a phenomenon which reduces the economic feasibility of governments, businesses and customers to avail the use of debt financing while it does result in an increase in savings related equity financing. In an investor’s eyes, during the timeframe of deflation, firms capable of hoarding huge cash reserves or having less loans to pay off are much more lucrative while the opposite holds true for companies ridden in debt and having weak cash holdings.

 

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