Question

Explain why deflation can be so troubling to borrowers and lenders.

Answer 1

Deflation is a state of persistent and substantial fall in general price level.

When there is deflation there comes a reduced business activity as it is not profitable for the investors.Investors become reluctant to borrow as they are doubtful about their profit .So lenders' lending activity does not happen.

Lenders quickly start to reduce many of their lending operations.First of all as the asset value falls customers can not back their debt with the same collateral.In that situation borrower finds unable to make their debt obligations ,and the lender finds it difficult to recover their money even through property seizures.Again lenders realize the financial position of the borrowers that is likely to change as employers start cutting their force and many may not be eligible for loans.

Borrowers also face troubles as when the productive activities fall they may lose their income in many ways like wage cut and retrenchment.They find it difficult to pay back their loans and have to face many legal actions.In the end deflation can bankrupt lenders as well as borrowers.