DEFLATION DEFINITION
Deflation is a sustained decrease in the average price level or a negative inflation rate.
Deflation is avoided because people hoard money and assets due to an increase in value.
This decreases consumer spending (GDP).
The 2% inflation rate lets there be a buffer between inflation and deflation.
GOOD DEFLATION
In an neoclassical AD-AS graph, if the LRAS curve shifts to the right, then there is an increase in real GDP, yet a decrease in the price level, assuming AD stays the same.
While a mostly theoretical scenario, this would be beneficial to the economy, and is called good delfation.
BAD DEFLATION
Bad deflation occurs when aggregate demand falls.
This means there is reduced economic growth, and thus it is bad delfation.
COSTS OF DEFLATION
Uncertainty
Lack of confidence leads to businesses and consumers being careful
Deferred Consumption
Consumers defer to spend money as their money is gaining value
Cyclical Unemployment
Deflation typically indicates falling economic output, meaning firms may have to lay off workers
Increase in Real Value of Debt
Size of real debt grows as money gains in purchasing power\
Re-distributive Effects
Winners: fixed income earners and lenders (banks).
Losers: borrowers and providers of fixed incomes (e.g. government).
Policy Ineffectiveness
Even with the use of expansionary monetary and fiscal policies, it will be difficult to convince firms and consumers to borrow money.