Deflation

Deflation

Is defined as the period of recession when the general level of prices falling. Usually associated with a lower level of AD, leading to the negative output gap GDP, where <real GDP is likely. But can also be caused by the contraction possible increase in the nation produced, leading to increased supply on aggregate demand. Will look at perhaps the most prominent example of a country that has suffered deflation - Japan's deflationary spiral - a little later in this note.

·       Possible Economic Costs of Deflation

v  Hold spending: Consumers may choose to defer consumption if they expect prices to fall again in the future

v   Increase the debt: The real value of households and companies and high government debt at lower price - and other factors that may cause people to reduce their expenditures
     

v  Increase the real cost of borrowing: Interest rates will rise if the real interest rates nominal Lalla in line with prices - another factor driving spending lower

v  Lower profit margins: the company's profit margins under pressure unless the costs fall further than the final prices to consumers - and this can lead to high rates of unemployment and companies seek to reduce costs. Weaker profit margins can also have a negative impact on stock markets because of the decline in expected profits and dividends to shareholders

v   And the prices of assets such as land prices in the housing market downturn, personal wealth and confidence in the financial sector - leading to further decline in the m and a rise in precautionary savings (average and marginal propensity to save will tend to rise): Trust and Savings
"Deflation over a long period, a general level of prices is falling. But just as there are many different strains of influenza, some fatal, including the production of discomfort only temporary, this is the case with the downturn. Just as it may generate a bad cold"-like symptoms symptoms of the flu, so it may carry some of the economies of the symptoms of deflation without suffering from the virus. "

Difference between Benign and Malign Deflation

Deflation is not necessarily bad! If you are the cause of lower prices by increasing productivity, as happened in the late 19th century, and then can go hand in hand with strong growth. On the other hand, if the downturn reflects a decrease in demand and excess capacity, and can be dangerous, as it was in the 1930s, causing a downward spiral of demand and prices. If falling prices are simply a result of improved technology or better management practices, there is nothing wrong. Consider what happened in the cost of transport and telecommunications over the years.

Today we have something benign deflation. When you make a phone call with the United States for a minute or 3P fly on a low-cost airline to European destinations for less than £ 30, the consumer is getting the benefit of technology and increased competition in the form of lower prices lead to an improvement in economic well-being!

            Malign Deflation

         Malign deflation occurs when prices fall due to lack of a structural demand, creating          huge excess capacity in the economic system. If there was a drop in demand, and companies go bankrupt and fire people, and therefore the decline in demand again - the impact of a negative multiplier effect by the start. !

The Situation in the UK

If there is deflation a real in many industries in the United Kingdom over the past few years, particularly in textiles, clothing and audio visual equipment and means of transport air, he saw the economy as a whole inflation is low, but positive as measured by the consumer price index. And mitigate the risk of contraction of the symmetrical inflation target given to the Bank of England - the recognition that deflation can be costly and also pose a threat to the health of the British economy as a sharp acceleration in inflation. Bank of England stands ready to increase aggregate demand by lowering interest rates if there is a serious threat of inflation under fire on the target. Another factor to consider is that inflationary expectations in Britain is still positive, or about 2.5% a year - people are not yet considered to be outright recession is likely to result for the economy.

Is defined low and stable inflation, which does not affect the day to day decisions of businesses and consumers, and price stability .. !

      Can economic policy reduce the risk of deflation?

      Monetary Policy

Could be cuts in interest rates to stimulate the demand for money, consumption and therefore boos. But this is not always an effective strategy to reduce the risk of deflation:

v   If consumer confidence is low, the impact of monetary incentives may be small and people are more likely to save any increase in income may have to enable it to repay some debt accumulated by the

v  If asset prices are declining, the demand for cash savings are still high - and therefore consumption may not respond to lower interest rates

v  There are limits to how far to go for monetary policy in the promotion of the size of the request because nominal interest rates can not fall below zero

When lower interest rates have little or no impact on demand, then the economy is said to be experiencing a liquidity trap. When interest rates are close to zero, and people might expect the real rate of little or no financial return on their investments, have chosen instead to simply stop liquidity rather than investing. If monetary policy and therefore not effective in stimulating demand, the solution may be to use fiscal policy as a means of kick-off of the request and output.

One possible solution is to seek to "liquidate the economy" by the large-scale buy-back government debt of the central banks to inject liquidity or cash in the economy. This option was considered by the Japanese government through which they suffer deflationary recession in the late 1990s.
One possible solution is to seek to "monetise the economy" by large scale buy-backs of government debt by the central bank to inject cash or liquidity into the economy. This was an option considered by the Japanese government during their deflationary recession in the late 1990s.

        Fiscal Policy

The fiscal expansion could come directly from M through increased government spending and / or increased borrowing in the public sector. Secondly, it may be a reduced risk of deflation by reducing direct taxes to increase the family income available. Each of these strategies seek to increase income and purchasing power of the injection of additional circular flow of income and expenditure. May be announced temporary tax cuts to deal with the threat of deflationary specific. But again there may be some limits to the effectiveness of fiscal policy in these circumstances:

1- There are consequences for the national debt and interest payments on this debt if the fiscal expansion package is very large. Government can ultimately provide a boost to short-term demand, but we have to deal with a substantial increase in the payment of debt in the coming years

2- Low and may reduce consumer confidence in the business of the impact of any new financial incentives

3- Reduce taxes and increase public spending may fuel some inflationary pressures have been applied if a lot of incentives for a very long time (once the economy begins to recover)
     If you are tax cuts or public works programs as temporary, while confidence is low, then additional income tend to be used to repay debt or restore the savings. We could see the families their priority, rather than increases in fuel consumption

Risks of deflation in the UK is relatively small. We must be careful to distinguish between inflation in the industries due to technological change, and increase the supply and regulatory intervention improvements or productivity - such as telecommunications, automotive and audio visual equipment, and the downturn in the economy as a whole, which raises many of the theoretically greater risk. Which provides economic policy makers and alert to the possible reasons for the contraction is real, and timely response when such risks are clear, then they have enough flexibility in the arsenals of monetary and fiscal policies to counter the threat posed by deflation.