Deflation is defined as a sustained decline in the general level of prices. In other words, the answer to the question of what is deflation is the constant cheapening of goods and services in the market. In deflationary environments, while the prices of goods or services get cheaper, the demand for them also decreases with the expectation that prices will continue to decline. In other words, in a deflationary economy, a good or service cannot find a buyer even though its price drops. As it can be understood from all these definitions, the definition of deflation operates in the opposite way to inflation in the economy.
What are the Causes of Deflation?
There may be different reasons for the formation of deflation. When the current credit and money supply decreases with the decisions of the central banks, a decrease in price can be observed in all the goods in the market.
Another factor that causes prices to fall is the decrease in the aggregate demand for goods and services. Among the reasons for such a recession may be the decrease in government expenditures, the decrease in the stock market, the consumer's desire to save and save, or the tightening tendencies in monetary policies.
In cases where the economy grows faster than the money and credit supply circulating in the market, a decrease in prices can be observed. This mostly occurs in situations where productivity in the economy increases with technological developments and the sectors that benefit from technology increase. Thus, while operational improvements are experienced, production costs decrease and this is reflected to the consumer as low prices. Thus, increased productivity can lead to deflation.
To briefly summarize the reasons for the formation of deflation;
- Increasing the propensity to save between producers and consumers,
- The decrease in the money supply,
- Decrease in purchasing power,
- Factors such as insufficient foreign demand.
In economies with deflation, it can be seen that large firms suffer great economic losses.
What Are the Consequences of Deflation?
Deflation can have various consequences in different areas. The effects of deflation can be listed as follows:
- Due to the economic recession, there is a decrease in the national income of the countries with deflation.
- With the increase in stock and the decrease in sales, the profits of the companies decrease.
- Unemployment increases with the decrease in profits in companies.
- Consumers tend to reduce consumption with the perception that prices will continue to fall.
- With the increase in the value of money, deterioration in the foreign trade balance begins.
- Due to the declines experienced, the capital owners give up on investing and prefer to direct their existing wealth to interest-bearing investment instruments. This leads to a further decrease in demand.
How Can Deflation Be Prevented?
It may be necessary to take various measures to prevent deflation, which negatively affects the country's economy. Deflation measures can be listed as follows:
- Public spending can be increased.
- Expenditures and investments can be encouraged through interest rate cuts.
- Increasing investments and expenditures can be supported by reducing tax rates.
- The wages of the employees can be increased.
- The private sector can be directed to invest through incentive practices.