When we hear “inflation,” we all imagine rising prices and cost-of-living increases. But then what if the opposite occurs—that prices begin to fall? Such an occurrence is called deflation (or reverse inflation), and one would expect, at first glance, that this is wonderful. Who wouldn’t want lower gasoline, food, and household items?
Yet, there are also the negative effects of deflation, and its impact on the economy may be even more negative than they appear at first sight. Throughout this article, we’ll investigate whether the so-called reverse inflation is actually sweet or maybe something that we should not be happy about.
What is Reverse Inflation (Deflation)?
Deflation occurs when the general price level of goods and services falls over time. It may happen due to a number of reasons, such as:
Fall in consumers’ demand
Rise in productivity and the consequent creation of an excess of goods.Contraction in the supply of money
Fall in lending and investment
Lower prices can seem like a good thing to consumers on the surface. But when deflation is persistent over time, it can lead to some very bad economic problems, impacting jobs, wages, and even businesses’ capacity to expand.
Why Deflation Can Be Bad
- People Spend Less (And That’s a Problem)
Suppose you were considering purchasing a new phone but heard that within a few months, prices will go even lower. What do you do? Most likely, everyone would wait in the hope that they get it cheaper someday. That seems logical on an individual basis, but if everyone waits to spend money, companies lose out. Fewer people buying means companies sell fewer, thus earn less money and ultimately end up losing their jobs.
- Debt Is Harder to Pay Back
As pay and prices fall, debt does not decrease—it remains the same or even greater. If you have a loan of $10,000, but your income falls as a result of deflation, then it is harder to pay back. That becomes a common issue that initiates increasing default rates and financial instability.
- Companies Reduce Hiring and Investment
When prices begin to fall and money is being spent less, businesses may be deterred from investing or expanding operations. Rather than new employees or new equipment, they’ll keep their cash. This reluctance to spend can slow down economic growth, and that’s why it becomes more difficult for businesses and workers to thrive.
- Rising Unemployment Rates
Wages are typically not falling as rapidly as costs, and that can be horrible for businesses. If businesses have to reduce costs but also share high labor costs, they then begin to shed employees in an effort to minimize costs. That creates even greater unemployment, which in turn causes consumer spending even further, creating a vicious cycle.
When Is Deflation Good?
Not all deflation is bad. In some cases, a mild decline in prices can be good:
Technological Advances: As the technology advances, the production becomes more affordable, and the consumers get lower prices. For instance, the prices of electronics have been declining steadily over the years because of better manufacturing techniques, but these sectors still grow.
Increased Buying Power: If you preserved and prices go down, you can purchase more using the same money. Savers and pensioners would benefit from this, as long as deflation doesn’t lead to large-scale redundancy or economic failure.
Lessons from History
Let us take two instances of how deflation affects us historically:
The Great Depression (1930s)
During the Great Depression, deflation further worsened things. Prices went down, businesses went bust, and unemployment expanded exponentially. Firms could not survive with decreased spending, and this led to an economic downturn.
Japan’s Lost Decade (1990s-2000s)
Japan had gone through a long period of deflation, which had resulted in slow economic growth. Prices may have been low, but nobody was spending, and companies were struggling to expand. The government was forced to adopt forceful monetary policies in an attempt to turn things around.
How Governments Combat Deflation
As deflation is perilous, governments and central banks take many tactics to avoid or combat deflation:
Lowering Interest Rates: It invites individuals to borrow and consume rather than retain cash.
Quantitative Easing: Central banks credit banks with cash in the hopes of spurring spending and investing.
Government Spending and Tax Cut: Governments encourage economic growth through higher government spending or taxation reduction.
Conclusion: Is Reverse Inflation a Good Thing?
Although lower prices are attractive, more harm than good can be done by deflation if it persists. It will result in job loss, increased debt, and stagnation of the economy. Although price reductions in certain industries (such as due to technological advancements) are good, overall deflation is usually an indicator of economic distress.
A healthy economy relies on fair balance—not so much inflation and not so much deflation. That is the reason why central banks always look for an inflation rate, usually around 2%, in an effort to keep things moving.
That is a blessing, cheapening prices appear to be, but the wider economic implications render deflation a problem that needs to be handled gingerly. Therefore, when prices begin to fall across the board, it isn’t necessarily something to be celebrated for—it can be a signal of warning.
