Question

Illustrate why deflation can be a serious economic problem. Maximum number of characters (including HTML tags added by text editor): 32,000

Answer 1

Deflation is defined as a fall in the general proce level. It is a negative rate of inflation. It means te value of money decreases.

Economic Problems of deflation:-

1. Discourage consumer spending - When there are falling prices, this often discourages people to delay purchases because they will be cheaper in future. It discourages consumer from buying luxury products.
2. Increase real value of debt. Deflation increases the real value of money and the real value of debt. Deflation makes it more difficult for debtors to pay off their debts
3. Increased real interest rates. Interest rates can’t fall below zero. If there is deflation of 2%, this means we have a real interest rate of + 2%. In other words saving money gives a reasonable return.
4. Real wage unemployment. Labour markets often exhibit ‘sticky wages’. In particular, workers resist nominal wage cuts (no one likes to see their wages actually cut, especially when you are used to annual pay increases. Therefore, in periods of deflation, real wages rise.
5. Deflation can become entrenched and difficult to end. The experience of Japan in the late 90s and 00s was that when deflation became the new norm, it was very hard to change inflation expectations and regain normal growth.