When the overall price level decreases so that inflation rate becomes negative, it is called deflation. It is the opposite of inflation.
Definition: When the overall price level decreases so that inflation rate becomes negative, it is called deflation. It is the opposite of the often-encountered inflation.
Description: A reduction in money supply or credit availability is the reason for deflation in most cases. Reduced investment spending by government or individuals may also lead to this situation. Deflation leads to a problem of increased unemployment due to slack in demand.
Central banks aim to keep the overall price level stable by avoiding situations of severe deflation/inflation. They may infuse a higher money supply into the economy to counter- balance the deflationary impact. In most cases, a depression occurs when the supply of goods is more than that of money.
Deflation is different from disinflation as the latter implies decrease in the level of inflation whereas on the other hand deflation implies negative inflation.
In economics, deflation is a decrease in the general price level of goods and services.[1] Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e., when inflation declines to lower levels).[2] Inflation reduces the real value of money over time; conversely, deflation increases the real value of money –- the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.
Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, and may aggravate recessions and lead to a deflationary spiral.[3] Historically not all episodes of deflation correspond with periods of poor economic growth.[4] Deflation occurred periodically in the U.S. during the 19th century (the most important exception was during the Civil War). This deflation was at times caused by technological progress that created significant economic growth, but at other times it was triggered by financial crises — notably the Panic of 1837 which caused deflation through 1844, and the Panic of 1873 which triggered the Long Depression that lasted until 1879.[5][6][7] These deflationary periods preceded the establishment of the U.S. Federal Reserve System and its active management of monetary matters. However, episodes of deflation have been rare and brief since the Federal Reserve was created (a notable exception being the Great Depression) while American economic progress has been unprecedented.
Although the values of capital assets are often casually said to "deflate" when they decline, this should not be confused with deflation as a defined term; a more accurate description for a decrease in the value of a capital asset is economic depreciation
Deflation started in the early 1990s in Japan. The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing', but did not create a sustained increase in broad money and deflation persisted. In July 2006, the zero-rate policy was ended.
Systemic reasons for deflation in Japan can be said to include:
• Tight monetary conditions. The Bank of Japan kept monetary policy loose only when inflation was below zero, tightening whenever deflation ends.[34]
• Unfavorable demographics. Japan has an aging population (22.6% over age 65) that is not growing and will soon start a long decline. The Japanese death rate recently exceeded its birth rate.
• Fallen asset prices. In the case of Japan asset price deflation was a mean reversion or correction back to the price level that prevailed before the asset bubble. There was a rather large price bubble in stocks and especially real estate in Japan in the 1980s (peaking in late 1989).
• Insolvent companies: Banks lent to companies and individuals that invested in real estate. When real estate values dropped, these loans could not be paid. The banks could try to collect on the collateral (land), but this wouldn't pay off the loan. Banks delayed that decision, hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks made even more loans to these companies that are used to service the debt they already had. This continuing process is known as maintaining an "unrealized loss", and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy. Improving bankruptcy law, land transfer law, and tax law have been suggested (by The Economist) as methods to speed this process and thus end the deflation.
• Insolvent banks: Banks with a larger percentage of their loans which are "non-performing", that is to say, they are not receiving payments on them, but have not yet written them off, cannot lend more money; they must increase their cash reserves to cover the bad loans.
• Fear of insolvent banks: Japanese people are afraid that banks will collapse so they prefer to buy (United States or Japanese) Treasury bonds instead of saving their money in a bank account. This likewise means the money is not available for lending and therefore economic growth. This means that the savings rate depresses consumption, but does not appear in the economy in an efficient form to spur new investment. People also save by owning real estate, further slowing growth, since it inflates land prices.
• Imported deflation: Japan imports Chinese and other countries' inexpensive consumable goods (due to lower wages and fast growth in those countries) and inexpensive raw materials, many of which reached all time real price minimums in the early 2000s. Thus, prices of imported products are decreasing. Domestic producers must match these prices in order to remain competitive. This decreases prices for many things in the economy, and thus is deflationary.
• Stimulus Spending: According to both Austrian and Monetarist economic theory, Keynesian 'stimulus' spending actually has a depressing effect. This is because the government is competing against private industry, and usurping private investment dollars.[35] In 1998, for example, Japan produced a 'stimulus' package of more than 16 trillion Yen, over half of it public works that would have a quashing effect on an equivalent amount of private, wealth-creating economic activity.[36]
Overall, Japan's 'stimulus' packages added up to over one hundred trillion Yen, and yet they failed. According to these economic schools, that 'stimulus' money actually perpetuated the problem it was intended to cure.
In November 2009 Japan has returned to deflation, according to the Wall Street Journal. Bloomberg L.P. reports that consumer prices fell in October 2009 by a near-record 2.2%
Eurozone is believed to be plunging into deflation as japan. The interest rates are kept low by ECB to improve influx of money into market. Value of debt increases . Suppose you had a debt of 100 Euro. Inflation means after some time it becomes smaller unit. Deflation means it becomes larger unit. Hence debt market is affected most. That’s the turmoil in Greece now. The largest return on bond after india is Greece. The problem is that due to deflaton, the value of money of debt has increased. So when you get return after maturity, the value of money is more because of deflation. Hence if you exchange it, the exchange money you get is more!!! Egs 100 euros bond you purchased. If you getting returns it after 1 year , due to deflation you get more rupees after exchange.
The ECB is relying on a weaker euro as its main defence against deflation but Japan’s travails shows that this is a risky strategy without powerful action to back it up. Stephen Jen from SLJ Macro Partners said it will take very large outflows of capital to offset the eurozone’s current account surplus of €230bn, and then to push the exchange rate down to €1.20 against the dollar, the minimum level needed to kick start a recovery. “If the ECB’s actions are too weak, the euro could perversely appreciate, just as the yen did from 1990 to 2012,” he said.
The Greek government-debt crisis is part of the ongoing European debt crisis, being triggered by the turmoil of the Great Recession, and believed to have been directly caused locally in Greece by a combination of structural weaknesses of the Greek economy along with a decade long pre-existence of overly high structural deficits and debt-to-GDP levels on public accounts. In late 2009, fears of a sovereign debt crisis developed among investors concerning Greece's ability to meet its debt obligations, due to a reported strong increase in government debt levels along with continued existence of high structural deficits. This led to a crisis of confidence, indicated by a widening of bond yield spreads and the cost of risk insurance on credit default swaps compared to the other countries in the Eurozone, most importantly Germany.
