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Deflation Worries

Sep 13, 2010 • Businesses, Demand, Supply, and Markets, Economic Debates, Macroeconomic Measurement, Money and Monetary Policy • 211 Views    3 Comments

We have something else to worry about: deflation.

If you had $100 in 2000, you would need $126.60 in 2010 to make the same kinds of purchases. Called inflation, prices tend to go up each year. Most consumers and businesses are happy with a little inflation, maybe 2% annually.  

Recently though, the inflation rate has been sinking which means that prices are rising more slowly. Then, when prices actually decline, as they did during April, May, and June, we have deflation. As you might expect, businesses respond poorly to falling prices. Predicting lower profits, they postpone expansion, lay off workers, and decrease wages. At .3%, the July inflation rate was slightly up again. 

During the Great Depression, deflation was a serious problem. Between the fall of 1929 and 1933, prices dropped almost 13%. An expert on the 1930s, our Fed Chair Ben Bernanke has said that we will never let that happen again. But others wonder whether we have sufficient economic knowledge to know what to do.

How would deflation affect you? Will you spend more or less if you expect prices to fall? Will you borrow money? 

The Economic Lesson 

Inflation has 3 basic causes: 1) Demand pulls prices up because too many buyers are chasing too few goods. 2) Costs push prices up because land, labor or capital becomes more expensive. 3) Prices generally can rise when one group with monopoly power raises the price of an important commodity such as oil.

The basic cause of deflation is a severe plunge in spending from consumers, businesses, and/or government. In response, to attract buyers, producers lower their prices and a deflation spiral can begin.

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  • EmilyMiller

    Mira makes a very good point! I like her point about people our age. I think that right now, we don’t realize how we will be affected as we are living at home and being supported by our parents; however, it is important to realize that very soon we will be financially independent and more directly feeling the pain of deflation in our own wallets.

  • A.NDiaye11

    I agree, deflation only leads to worse things in the future. People begin to lose the motivation and confidence to buy products because they believe they will recieve nothing in return. People my age are directly affected.

  • korberm11

    Deflation creates a vicious cycle. Because companies slow down their production, workers lose income, and then do not spend money on unnecessary goods. The economy falters, and people lose confidence in money’s value as prices continue to sink. Deflation affects people my age fairly directly. It may seem that people would spend more because prices are lower, but the opposite may happen. People will spend less because it seems that there will be no return on an investment. The Real Estate crash is an example of the consequences of over inflation and rubber stamped mortgages followed by an economic downturn and sudden worthlessness of previously highly liquid assets.

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