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What Is Deflation?

Views 18282022.09.21
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Key Takeaways

● Deflation is a decrease in the general price level of goods and services in economics.

● Inflation rate = (Final CPI Index Value - Initial CPI Value) / Initial CPI Value*100%

● By definition, a fall in the supply of money or financial instruments redeemable in money can result in monetary deflation.

Understanding

Deflation is when the inflation rate is negative. When consumer prices fall uniformly, it happens. Typically, a decline in consumer spending and a reduction in the demand for goods and services cause price reductions and the ensuing deflation. Increased purchasing power results from deflation.

Deflation can be a sign of a recession or other economic instability, despite the fact that many customers could view this as a positive development. Typically, a recession is characterized by falling stock prices, fewer jobs, and lower earnings.

The Consumer Price Index (CPI) is in charge of calculating the rates of inflation and deflation.

What Causes Deflation

Deflation is primarily brought on by a decline in the cost of consumer goods and services, which happens when there is a reduction in the demand for such goods and services relative to the supply.

A decrease in the amount of money available could be the cause of this decreased demand. The Federal Reserve has the power to alter the amount of money in circulation and make it more difficult to get money by boosting lending interest rates. People spend less when it's tougher to earn money.

An rise in output may also lead to deflation. Companies can charge less for products when manufacturing them becomes simpler and less expensive.

Lastly, a decline in government spending may have an impact on demand. Let's imagine, for illustration, that infrastructure funding is reduced by the government. Some families in those affected areas, like the construction industry, suddenly have less money to spend. Prices normally decrease as demand declines, and vice versa.

A Historical Example of Deflation

Possibly the most well-known instance of deflation is the Great Depression, which got its start on September 4, 1929, when the stock market crashed. During those years, the inflation rate decreased to a negative figure, occasionally dropping below -10%.

Many people didn't have any money to spend because they were either laid off or weren't paid enough. During the Great Depression, the unemployment rate was close to 25%. The Great Depression serves as a perfect illustration of how the deflationary spiral descends.

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