Thu. Jan 27th, 2022

Most people know the word inflation, which usually has a negative connotation. However, in economic terms, deflation it’s actually a worse prospect. In monetary policy, it can refer to the global reduction of the money supply or to the decrease in the cost of consumer goods and services. On inflation it means a rise in prices and a fall in purchasing power, deflation indicates a complete lack of purchasing power.

In fact, it is a form of economic contraction. He points to a depressive period that by its very nature can further perpetuate the economic recession. Fortunately, the Federal Reserve can use strategic monetary policy to prevent or combat it. Fighting deflation begins with understanding it. This is what investors and companies need to know.

Understand the differences between deflation and inflation

Deflation correlates with depression

Looking for historical examples of deflation? The best place to start is with significant falls and stock market corrections. The Great Depression (1929-1933) was the largest deflationary period in U.S. history. The Great Recession (2007-2009) was another important deflationary period.

The correlation between deflation and depression occurs because they share the same catalysts. Deflation often breeds economic depression. Specifically, it is a cyclical series of events that trigger them:

  • Lower benefits. Decreasing consumer demand causes sales and revenue to fall, which ultimately reduces corporate profitability.
  • Bankruptcy. Lower profits lead to insolvency, forcing companies to file for bankruptcy.
  • Atur. Bankruptcy applications are usually filed for layoffs and layoffs, which raises the unemployment rate.
  • Lower income. Unemployed people and households have lower incomes and therefore have no purchasing power beyond basic materials.
  • Lower demand. Lower incomes lead to tax conservation, resulting in fewer incentives to spend money off the essentials.

This whole process is perpetuated, which increases deflation and initiates economic depression. This is why it is so dangerous and important to recognize economic signs and potential signals.

What causes deflation?

What starts the deflation cycle? The answer is there are usually several different catalysts, but they all share a common factor: contraction. Whether it is money supply or access to capital, where there is a contraction, deflation is usually followed.

  • Decrease in the money supply. When people don’t have access to money, they can’t spend it. Similarly, when companies cannot easily access capital, they cannot grow.
  • Decreased government spending. When government spending is contracted, so do all comparative markets, that is, almost all financial markets.
  • Decreased business investment. Companies that cannot access capital do not reinvest it in the economy again, which can reduce profits and productivity.
  • Decreased consumer demand. As consumer spending goes down, demand decreases, which affects the profitability of companies.

Many of these catalysts are the direct result of the economic depression. It can be difficult to know exactly where deflation begins and what causes (or causes). Did a decline in consumer demand cause companies to lay off workers or did layoffs cause a drop in consumer demand? Deflation illustrates the interconnectedness and complexity of the economy.

How to fight

Central banks are key to fighting deflation. Specifically, the Federal Reserve can enact a monetary policy to increase spending and demand putting more money into circulation and controlling interest rates. Some of the strategies that food will use to prevent the deflationary spiral and economic contraction include:

  • Reduction of bank reserves to increase the money supply
  • Quantitative facilitation, to exercise control over the money supply
  • Reduction of target interest rates to improve access to capital
  • Negative interest rates, to attract debt
  • Increased public spending, to improve market confidence
  • Reduction of tax rates, to alleviate the financial burdens of companies and consumers

The fight against deflation usually involves increasing access to cash and giving people confidence to spend it. Depending on the cause, the power supply can remove one or many of these levers to slow down and reverse the rate of deflation, to prevent recession or depression.

Deflation is not always bad

Deflation on a macro scale is a bad sign; however, in specific cases, it is not necessarily bad. For example, technology has reduced costs in many sectors, making the price of goods and services more affordable. In these situations, price deflation is present while accessibility has increased. The result has driven the expansion of the sector in general.

There is no better example of positive deflation than the cost of data. In 1980, the the cost of a single gigabyte of data was $ 437,500; today it is about a penny. This massive deflation has not killed the telecommunications industry, but has made it a widely accessible service for more consumers and boosted profitability to new heights.

How companies and investors cope

During periods of deflation, companies need to focus on the balance sheet. This means reducing liabilities and accumulating assets. The most important concern of a business is to cover its outstanding liabilities in the face of declining sales and consumer demand. Cash reserves and minimum debt are solid positions in which it finds itself when deflation arrives.

For investors (and consumers), deflation can be an opportunity, as long as your personal finances are not affected by job loss or bankruptcy. Falling prices mean an increase in purchasing power. It is also an opportunity to make smart investments in stable companies.

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Like inflation, deflation is a difficult topic to navigate and can mean different things depending on the context. It is important for both companies and investors to understand how deflationary periods affect them and how to make the most of the situation as monetary policy corrections come into play.

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