4 problems of deflationIn this post, Erica Fellinger, professor of the International Master's Degree in Business Administration and Management at Bureau Veritas University Center, talks to us about the problems of deflation.
As is well known, the objective of price stability in the economy is important because prices are necessary signals for economic agents to make decisions . Thus, entrepreneurs decide how much and what to produce and sell; and, therefore, how much and in what to invest. On the other hand, consumers decide how much and what to buy.
Ultimately, in economic terms, prices are necessary signals for the proper allocation of resources . We are used to recognizing some costs of inflation, even without being experts in economics. How bc data many times do we hear or read that the competitiveness of the economy improves when inflation falls, for example? But what happens if the price level falls so much that we find ourselves with negative growth rates? In this case, we are talking about deflation.
As with inflation, deflation also causes problems in the economy. Let's look at the four main problems :
Effects on consumption: Consumers postpone their purchasing decisions because in the future they will be able to do so at lower prices, therefore, they reduce current consumption .
Deterioration of business results: The decrease in consumption leads to a drop in sales and production , which in turn leads to a decrease in business results .
Destruction of employment: The fall in consumption and the chain effects it produces on business results and production, spread to employment and this increases the unemployment rate .
Effects on the real value of debts: Falling prices cause debtors to increase the value of their debts in real terms. This harms debtors and benefits creditors . To understand this effect, let us consider that the nominal value of the debt is what is written, for example, in a one-year rental contract. If we have to pay 1,000 euros each month to rent a flat, we must think in real terms, that is, the amount of goods that we could buy with 1,000 euros. Let us imagine that in January of a year, we could buy 100 kg of meat. After a period of deflation and, therefore, lower prices, at the end of that year we could buy more than 100 kg of meat with 1,000 euros. Or, in other words, 1,000 euros in real terms represent much more in December than in January of that same year. The creditor, the owner of the flat, when he receives the 1,000 euros is the one who will be able to buy more kilos of meat. Therefore, we affirm that debtors increase the value of their debts in real terms, an undesirable redistribution of income between debtors and creditors occurs.