Two terms - “inflation” and “deflation” - are inextricably linked with each other and refer to the economic sphere of human activity. However, they represent completely opposite phenomena. Deflation is a rise in price of money, inflation is a cheapening. Both the first and the second have a huge impact on individual citizens, states, and even on international economic and political relations.
What does the term "deflation" mean?
This phenomenon in the economy represents an increase in the purchasing power of a currency. The characteristic features of deflation are:
- lower prices for everything in the country's economy (the higher the deflation index, the stronger the prices go down);
- regular recalculation of prices for goods and services;
- lower wages, based on the appreciation of the currency.
In general, the terms inflation and deflation themselves were used exclusively in the academic environment until the second half of the 20th century. But in the postwar period, they began to appear in the scientific literature. It was then that economic theory began to develop widely and penetrate the masses. Keynes, an American economist, was a prominent figure who studied the laws of deflation. Under the influence of his reasoning, the words “inflation” and “deflation” began to appear more and more often in everyday speech.
Reasons for deflation
In order to answer the question of what deflation is, in simple terms, it is necessary to study its causes. Modern economists identify three main causes of deflation in the economy:
- The value of money. With a state of rising cost of production, the value of money rises. This applies when using natural money, i.e. money with any material content, most often gold, less often in another standard, for example, the German brand was supported by grain.
- Cost of goods. The price of goods on the market will certainly decrease due to increase labor productivity. At the same time, the cost of money is at a constant level.
- Shortage of money. In the form of an artificial increase in the value of money, a decrease in the money supply is manifested. Thus, deflation is the consequence of the withdrawal by the central bank of a certain amount of banknotes from circulation. This is achieved in various ways, for example, by raising the tax rate, preventing wage increases, lowering state budget expenditures, etc. These actions lead to a reduction in inflation due to an artificial increase in the value of the currency.
From the point of view of the consumer
For the consumer (i.e., a simple citizen), this state of affairs in the economy is quite a positive phenomenon. Let’s take, for example, a simple worker, Vasya. In January, he received a salary of 1000 rubles. With this money, he bought 3 bags of potatoes. In February, Vasya received the same 1000, but due to an increase in the cost of money, he managed to purchase, in addition to 3 bags of potatoes, another 1 bag of onions. In the event that there is no reduction in wages, Vasya is happy with everything, and he even begins to save money. Thus, for consumers, deflation is a chance to increase their well-being, in the event that there is no increase in taxes and lower salaries.
From the point of view of the manufacturer
For the manufacturer, the situation with deflation is exactly the opposite. This situation develops, for example, an entrepreneur took a loan from a bank for the development of his own business in the amount of 1000 rubles. He begins to produce potatoes. In January, he sold potatoes for 5 rubles. In February, after the rise in price of money, he already sells not at 5, but at 4 rubles per kilogram.If you look at the amount of profit received, it will certainly fall. A loan of 1000 rubles will certainly rise in price. Thus, the borrower will give the amount of money the same, but here its value with a difference of several months or even years will be very different.
Deflation is a crisis, at least for the producer. And since we live in market relations today, this will have an impact on the entire economic system of the state. Thus, deflation for the financial system is even more dangerous than inflation.
Negative effects on the economy
The prominent economist of today Wassel David, analyzing what deflation is in the economy of states, identified 4 main points of its negative impact:
- Periodic lowering of workers' wages.
- Due to the development of the legal framework in most countries, it will be difficult for an entrepreneur to fire redundant workers, as a result, he will incur additional costs, which will lead to a general decrease in profits.
- The consumer, noting the process of constant decline in prices for goods, will postpone purchases until tomorrow.
- This phenomenon is highly undesirable to debtors and the Central Bank.
Examples of deflation in world history
This phenomenon is not new; it has been accompanying economic development for several decades. Deflation (examples of it can be found) will become clear if you even dive a little into the study of the economic development of some countries.
The Great Depression. In 1929, a catastrophic collapse occurred on the New York Stock Exchange, a huge number of banks went bankrupt, and depositors lost their savings. All these events led to unprecedented deflation, the reason for all this was the artificial bloating of the “credit bubble”, followed by its bursting.
Another striking example is the “lost decade” in Japan. In the late 80s of the last century, the state carried out an artificial increase in demand for real estate, which led to an unprecedented increase in prices. For example, the land under the imperial palace was assessed on a par with all the land in California. For a long time, the situation of appreciation could not occur, and after the “burst” of an artificial speculative bubble, a series of bankruptcy of banks and credit capital began. After that, the Japanese government tried to inflate the bubble again, but banks and large industrial capital no longer wanted to step on the same rake again. As a result, today in Japan there is practically no demand for land and real estate, although there are very few free territories there, the price for them falls from year to year.
As a result, answering the question of what deflation is, in simple terms, is not so difficult. In a nutshell - this is an increase in the value of money, either artificial, through the withdrawal from circulation of a certain amount of money supply, or in a natural way, through an increase in production. In both the first and second cases, this process will affect both the consumer and the producer, touching the pocket of a simple citizen and the whole state.
