The effects of deflation

If inflation can be dangerous, the opposite, that is the generalized fall in prices known as deflation, can also damage the people and the economy of a country: consumers may decide to postpone their purchases while waiting for prices to decrease; household spending will decrease and, consequently, businesses may cut back on their investments and employees, setting off a chain reaction which affects consumption and the economy as a whole (a deflationary spiral).

Contrary to inflation, deflation may lead to an increase in the purchasing power of our income and savings in the short term; on the other hand, debtors will be penalized by the fall in prices, because the money they owe will have a higher real value. In the long term, wages will fall, or maybe even disappear due to job loss or decreased turnover!

Deflation and the lost decade

One of the most famous instances of deflation was in Japan from the early 1990s to the early 2000s.

A number of factors - including a period of crisis for the main Asian economies, as well as a drop in Japanese real estate value - contributed to Japan experiencing a prolonged period of internal demand stagnation; demand increased slightly some years, in other years it decreased and this led to general price stagnation.

We talk about the lost decade because Japanese citizens, who expected prices to keep decreasing, postponed their purchases, thus creating problems for businesses, which were forced to downsize their employees. Deflation is a conundrum: even when the Japanese economy bounced back, the prices of some categories of goods, such as clothing, kept decreasing.

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