Answer the following questions

Deflation

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e., when inflation declines to lower levels). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, and may aggravaterecessions and lead to a deflationary spiral. Historically not all episodes of deflation correspond with periods of poor economic growth. Deflation occurred in the U.S. during most of the 19th century (the most important exception was during the Civil War). This deflation was caused by technological progress that created significant economic growth.

Debt deflation (debt deflation is a complicated phenomenon associated with the end of long-term credit cycles. It was proposed as a theory by Irving Fisher (1933) to explain the deflation of the Great Depression).

Credit deflation (in modern credit-based economies, deflation may be caused by the central bank initiating higher interest rates. In a credit-based economy, a slow-down or fall in lending leads to less money in circulation, with a further sharp fall in money supply as confidence reduces and velocity weakens, with a consequent sharp fall-off in demand for employment or goods. The fall in demand causes a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production, or repaying debt levels incurred at the prior price level. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets which have fallen dramatically in value since their mortgage loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation. To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans (as in Japan, and most recently America and Spain). This is often no more than a stop-gap measure, because they must then restrict credit, since they do not have money to lend, which further reduces demand).

A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price.

Exercises

Give synonyms to the underlined words

Answer the following questions

· Why do falling prices make people expect falling prices?

· But what about wages and what about asset prices in the period of deflation?

· Why do sellers not lower prices?

· What are people doing with the money that they did not spend?

· Is this really what caused the Great Depression?

· Is inflation or deflation a greater threat to the world economy?

Date: 2015-12-24; view: 700