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What is deflation?

Lilya Mayak
Lilya Mayak
March 7, 2015
What is deflation?

About the concept of inflation, perhaps, heard almost everything. You can read about it also in our article What is inflation. But very few people know that inflation has the opposite phenomenon — deflation, which means increasing the purchasing power of a country's money. This phenomenon leads to a decrease in the price index. Read more about what deflation is discussed in our article.

The main causes of deflation and its consequences

One of the main causes of deflation can be called the increase in the value of money and their lack of turnover. The second main reason is the decrease in available loans. The growth of labor productivity also leads to this phenomenon, due to which the cost of goods decreases, but the value of the country's currency remains unchanged.

All of the above factors lead to negative phenomena in the economy. First, because of pending demand, domestic consumption is slowing. It means,that the population is waiting for lower prices and refuses to purchase goods and services.

Disruptions in the functioning of the financial sector also occur as loans become more expensive. Foreign trade volumes are significantly reduced, since foreign companies prefer to cooperate with countries with weak currencies. The real value of foreign debt also rises during deflation, and this introduces difficulties in servicing his country.

Ways to reduce deflation

The regulation of the deflation process by the state implies several basic actions:

  1. Reducing government spending.
  2. Restriction of money supply.
  3. Raising interest rates on loans.
  4. Tax increase.

However, some of these methods are not always effective. For example, if a decrease in state expenditures results in a sharp reduction in some budget items, then it is very likely that against this background the rise in unemployment in the country will increase. This will lead to the opposite result, as the country will need to increase its spending for social security of the increased number of unemployed.Therefore, one should adhere to another principle and, first of all, reduce the financing of already independent types of activity.

The same applies to raising taxes. Their growth, as a rule, gives only a short-term result. Conducting such a policy for a long time usually leads to a decrease in investment and inhibition in the country's economy.

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