Economy

Deflation

The term deflation refers to a contraction that occurs in money supply circulating within an economy, and therefore we can say that it is the opposite of inflation. In times of deflation, the purchasing power of the currency and wages are higher than they might otherwise have been. This is different but similar to price deflation, which is a general decline in the level of prices, although the two terms are often confused and used interchangeably.

Deflation

Related topics

Stagflation, inflation

What is deflation?

It is the fall in product prices over a period of time considered long, excluding price falls in specific sectors.

In effect, deflation makes the nominal costs of capital, labor, goods and services lower than if the money supply were not reduced. While price deflation is often a side effect of monetary deflation, this is not always the case.

Characteristics of deflation

Among the main characteristics that we can mention of deflation, the following are mentioned:

History

The history of deflation dates back to the 19th century, in the United States, when the word “inflation” began to be used to criticize the different governments’ actions that put too much money into circulation, increasing the economy out of control and causing prices to rise. The word was also used to mean a price increase.

Types

There are three types of deflation:

Causes of deflation

Monetary deflation can only be caused by a decrease in the money supply or in the different financial instruments redeemable in money. At present, money supply is more influenced by central banks. Periods of deflation most commonly occur after long periods of artificial monetary expansion.

There are two main causes of price deflation. The first is a general increase in the demand for cash savings by consumers and businesses because consumers are uncertain, or because their time preferences for consumption have lengthened. The second cause is a general increase in economic productivity, which increases the supply of goods and increases the purchasing power of incomes.

Consequences

The consequences of deflation are:

Advantages of deflation

The advantage of deflation is that in order to combat it, interest rates must be lowered, which causes that currency power to be greater and, in a normal context, citizens with purchasing power consume more and also entrepreneurs without problems tend to increase their investments.

Disadvantages

Examples

Written by Gabriela Briceño V.
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