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Deflation

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). Inflation reduces the value of currency over time, but sudden deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e., when inflation declines to a lower rate but is still positive.[2]

Economists generally believe that a sudden deflationary shock is a problem in a modern economy because it increases the real value of debt, especially if the deflation is unexpected. Deflation may also aggravate recessions and lead to a deflationary spiral.[3][4][5][6][7][8][9]

Some economists argue that prolonged deflationary periods are related to the underlying of technological progress in an economy, because as productivity increases (TFP), the cost of goods decreases.[10]

Deflation usually happens when supply is high (when excess production occurs), when demand is low (when consumption decreases), or when the money supply decreases (sometimes in response to a contraction created from careless investment or a credit crunch) or because of a net capital outflow from the economy.[11] It can also occur due to too much competition and too little market concentration.[12][better source needed]

Causes and corresponding types Edit

In the IS–LM model (investment and saving equilibrium – liquidity preference and money supply equilibrium model), deflation is caused by a shift in the supply and demand curve for goods and services. This in turn can be caused by an increase in supply, a fall in demand, or both.

When prices are falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity. When purchases are delayed, productive capacity is idled and investment falls, leading to further reductions in aggregate demand. This is the deflationary spiral. The way to reverse this quickly would be to introduce an economic stimulus. The government could increase productive spending on things like infrastructure or the central bank could start expanding the money supply.

Deflation is also related to risk aversion, where investors and buyers will start hoarding money because its value is now increasing over time.[13] This can produce a liquidity trap or it may lead to shortages that entice investments yielding more jobs and commodity production. A central bank cannot, normally, charge negative interest for money, and even charging zero interest often produces less stimulative effect than slightly higher rates of interest. In a closed economy, this is because charging zero interest also means having zero return on government securities, or even negative return on short maturities. In an open economy it creates a carry trade, and devalues the currency. A devalued currency produces higher prices for imports without necessarily stimulating exports to a like degree.

Deflation is the natural condition of economies when the supply of money is fixed, or does not grow as quickly as population and the economy. When this happens, the available amount of hard currency per person falls, in effect making money more scarce, and consequently, the purchasing power of each unit of currency increases. Deflation also occurs when improvements in production efficiency lower the overall price of goods. Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods, and consequently, deflation has occurred, since purchasing power has increased.

Rising productivity and reduced transportation cost created structural deflation during the accelerated productivity era from 1870 to 1900, but there was mild inflation for about a decade before the establishment of the Federal Reserve in 1913.[14] There was inflation during World War I, but deflation returned again after the war and during the 1930s depression. Most nations abandoned the gold standard in the 1930s so that there is less reason to expect deflation, aside from the collapse of speculative asset classes, under a fiat monetary system with low productivity growth.

 
  Deflation
  M2 money supply increases year/year

In mainstream economics, deflation may be caused by a combination of the supply and demand for goods and the supply and demand for money, specifically the supply of money going down and the supply of goods going up. Historic episodes of deflation have often been associated with the supply of goods going up (due to increased productivity) without an increase in the supply of money, or (as with the Great Depression and possibly Japan in the early 1990s) the demand for goods going down combined with a decrease in the money supply. Studies of the Great Depression by Ben Bernanke have indicated that, in response to decreased demand, the Federal Reserve of the time decreased the money supply, hence contributing to deflation.

Causes include, on the demand side:

  • Growth deflation
  • Hoarding

And on the supply side:

  • Bank credit deflation
  • Debt deflation
  • Money supply-side decision
  • Credit deflation

Growth deflation Edit

Growth deflation is an enduring decrease in the real cost of goods and services as the result of technological progress, accompanied by competitive price cuts, resulting in an increase in aggregate demand.[15]

A structural deflation existed from the 1870s until the cycle upswing that started in 1895. The deflation was caused by the decrease in the production and distribution costs of goods. It resulted in competitive price cuts when markets were oversupplied. The mild inflation after 1895 was attributed to the increase in gold supply that had been occurring for decades.[16] There was a sharp rise in prices during World War I, but deflation returned at the war's end. By contrast, under a fiat monetary system, there was high productivity growth from the end of World War II until the 1960s, but no deflation.[17]

Historically not all episodes of deflation correspond with periods of poor economic growth.[18]

Productivity and deflation are discussed in a 1940 study by the Brookings Institution that gives productivity by major US industries from 1919 to 1939, along with real and nominal wages. Persistent deflation was clearly understood as being the result of the enormous gains in productivity of the period.[19] By the late 1920s, most goods were over supplied, which contributed to high unemployment during the Great Depression.[20]

Bank credit deflation Edit

Bank credit deflation is a decrease in the bank credit supply due to bank failures or increased perceived risk of defaults by private entities or a contraction of the money supply by the central bank.[21]

Debt deflation Edit

Debt deflation is a complicated phenomenon associated with the end of long-term credit cycles. It was proposed as a theory by Irving Fisher (1933) to explain the deflation of the Great Depression.[22]

Money supply-side deflation Edit

From a monetarist perspective, deflation is caused primarily by a reduction in the velocity of money and/or the amount of money supply per person.

A historical analysis of money velocity and monetary base shows an inverse correlation: for a given percentage decrease in the monetary base the result is a nearly equal percentage increase in money velocity.[13] This is to be expected because monetary base (MB), velocity of base money (VB), price level (P) and real output (Y) are related by definition: MBVB = PY.[23] However, the monetary base is a much narrower definition of money than M2 money supply. Additionally, the velocity of the monetary base is interest-rate sensitive, the highest velocity being at the highest interest rates.[13]

In the early history of the United States, there was no national currency and an insufficient supply of coinage.[24] Banknotes were the majority of the money in circulation. During financial crises, many banks failed and their notes became worthless. Also, banknotes were discounted relative to gold and silver, the discount depended on the financial strength of the bank.[25]

In recent years changes in the money supply have historically taken a long time to show up in the price level, with a rule of thumb lag of at least 18 months. More recently Alan Greenspan cited the time lag as taking between 12 and 13 quarters.[26][full citation needed] Bonds, equities and commodities have been suggested as reservoirs for buffering changes in the money supply.[27]

Credit deflation Edit

In modern credit-based economies, deflation may be caused by the central bank initiating higher interest rates (i.e., to 'control' inflation), thereby possibly popping an asset bubble. In a credit-based economy, a slow-down or fall in lending leads to less money in circulation, with a further sharp fall in money supply as confidence reduces and velocity weakens, with a consequent sharp fall-off in demand for employment or goods. The fall in demand causes a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production, or repaying debt levels incurred at the prior price level. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets that have fallen dramatically in value since their mortgage loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation. To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans (as in Japan, and most recently America and Spain). This is often no more than a stop-gap measure, because they must then restrict credit, since they do not have money to lend, which further reduces demand, and so on.

Historical examples of credit deflation Edit

In the early economic history of the United States, cycles of inflation and deflation correlated with capital flows between regions, with money being loaned from the financial center in the Northeast to the commodity producing regions of the [mid]-West and South. In a procyclical manner, prices of commodities rose when capital was flowing in, that is, when banks were willing to lend, and fell in the depression years of 1818 and 1839 when banks called in loans.[28] Also, there was no national paper currency at the time and there was a scarcity of coins. Most money circulated as banknotes, which typically sold at a discount according to distance from the issuing bank and the bank's perceived financial strength.

When banks failed their notes were redeemed for bank reserves, which often did not result in payment at par value, and sometimes the notes became worthless. Notes of weak surviving banks traded at steep discounts.[24][25] During the Great Depression, people who owed money to a bank whose deposits had been frozen would sometimes buy bank books (deposits of other people at the bank) at a discount and use them to pay off their debt at par value.[29]

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.[14][25][28] These deflationary periods preceded the establishment of the U.S. Federal Reserve System and its active management of monetary matters. Episodes of deflation have been rare and brief since the Federal Reserve was created (a notable exception being the Great Depression) while U.S. economic progress has been unprecedented.

A financial crisis in England in 1818 caused banks to call in loans and curtail new lending, draining specie out of the U.S.[citation needed] The Bank of the United States also reduced its lending. Prices for cotton and tobacco fell. The price of agricultural commodities also was pressured by a return of normal harvests following 1816, the year without a summer, that caused large scale famine and high agricultural prices.[30]

There were several causes of the deflation of the severe depression of 1839–1843, which included an oversupply of agricultural commodities (importantly cotton) as new cropland came into production following large federal land sales a few years earlier, banks requiring payment in gold or silver, the failure of several banks, default by several states on their bonds and British banks cutting back on specie flow to the U.S.[28][31]

This cycle has been traced out on a broad scale during the Great Depression. Partly because of overcapacity and market saturation and partly as a result of the Smoot–Hawley Tariff Act, international trade contracted sharply, severely reducing demand for goods, thereby idling a great deal of capacity, and setting off a string of bank failures.[20] A similar situation in Japan, beginning with the stock and real estate market collapse in the early 1990s, was arrested by the Japanese government preventing the collapse of most banks and taking over direct control of several in the worst condition.

Scarcity of official money Edit

The United States had no national paper money until 1862 (greenbacks used to fund the Civil War), but these notes were discounted to gold until 1877. There was also a shortage of U.S. minted coins. Foreign coins, such as Mexican silver, were commonly used.[24] At times banknotes were as much as 80% of currency in circulation before the Civil War. In the financial crises of 1818–19 and 1837–1841, many banks failed, leaving their money to be redeemed below par value from reserves. Sometimes the notes became worthless, and the notes of weak surviving banks were heavily discounted.[25] The Jackson administration opened branch mints, which over time increased the supply of coins. Following the 1848 finding of gold in the Sierra Nevada, enough gold came to market to devalue gold relative to silver. To equalize the value of the two metals in coinage, the US mint slightly reduced the silver content of new coinage in 1853.[24]

When structural deflation appeared in the years following 1870, a common explanation given by various government inquiry committees was a scarcity of gold and silver, although they usually mentioned the changes in industry and trade we now call productivity. However, David A. Wells (1890) notes that the U.S. money supply during the period 1879-1889 actually rose 60%, the increase being in gold and silver, which rose against the percentage of national bank and legal tender notes. Furthermore, Wells argued that the deflation only lowered the cost of goods that benefited from recent improved methods of manufacturing and transportation. Goods produced by craftsmen did not decrease in price, nor did many services, and the cost of labor actually increased. Also, deflation did not occur in countries that did not have modern manufacturing, transportation and communications.[14]

By the end of the 19th century, deflation ended and turned to mild inflation. William Stanley Jevons predicted rising gold supply would cause inflation decades before it actually did. Irving Fisher blamed the worldwide inflation of the pre-WWI years on rising gold supply.[32]

In economies with an unstable currency, barter and other alternate currency arrangements such as dollarization are common, and therefore when the 'official' money becomes scarce (or unusually unreliable), commerce can still continue (e.g., most recently in Zimbabwe). Since in such economies the central government is often unable, even if it were willing, to adequately control the internal economy, there is no pressing need for individuals to acquire official currency except to pay for imported goods.

Currency pegs and monetary unions Edit

If a country pegs its currency to one of another country that features a higher productivity growth or a more favourable unit cost development, it must – to maintain its competitiveness – either become equally more productive or lower its factor prices (e.g., wages). Cutting factor prices fosters deflation. Monetary unions have a similar effect to currency pegs.

Effects Edit

On spending and borrowing Edit

Some believe that, in the absence of large amounts of debt, deflation would be a welcome effect because the lowering of prices increases purchasing power.[33] However, while an increase in the purchasing power of one's money benefits some, it amplifies the sting of debt for others: after a period of deflation, the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred. Consequently, deflation can be thought of as an effective increase in a loan's interest rate. If, as during the Great Depression in the United States, deflation averages 10% per year, even an interest-free loan is unattractive as it must be repaid with money worth 10% more each year.

Under normal conditions, most central banks, such as the Federal Reserve, implement policy by setting a target for a short-term interest rate – the overnight federal funds rate in the U.S. – and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target. With interest rates near zero, debt relief becomes an increasingly important tool in managing deflation.

In recent times, as loan terms have grown in length and loan financing (or leveraging) is common among many types of investments, the costs of deflation to borrowers has grown larger.

On savings and investments Edit

Deflation can discourage private investment, because there is reduced expectations on future profits when future prices are lower. Consequently, with reduced private investments, spiraling deflation can cause a collapse in aggregate demand. Without the "hidden risk of inflation", it may become more prudent for institutions to hold on to money, and not to spend or invest it (burying money). They are therefore rewarded by saving and holding money. This "hoarding" behavior is seen as undesirable by most economists.[citation needed] Friedrich Hayek, a libertarian Austrian-school economist, wrote that:

It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.

— Hayek (1932)[34]

Compared with inflation Edit

Deflation causes a transfer of wealth from borrowers and holders of illiquid assets to the benefit of savers and of holders of liquid assets and currency, and because confused price signals cause malinvestment in the form of underinvestment. In this sense, its effects are the opposite of inflation, the effect of which is to transfer wealth from currency holders and lenders (savers) and to borrowers, including governments, and cause overinvestment. Whereas inflation encourages short term consumption and can similarly overstimulate investment in projects that may not be worthwhile in real terms (for example, the dot-com and housing bubbles), deflation reduces investment even when there is a real-world demand not being met. In modern economies, deflation is usually associated with economic depression, as occurred in the Great Depression and the Long Depression. Deflation was present during most economic depressions in US history.[35][better source needed]

Deflationary spiral Edit

A deflationary spiral is a situation where decreases in the price level lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in the price level.[36][37] Since reductions in general price level are called deflation, a deflationary spiral occurs when reductions in price lead to a vicious circle, where a problem exacerbates its own cause.[38] In science, this effect is also known as a positive feedback loop. Another economic example of this situation in economics is the bank run.

The Great Depression was regarded by some as a deflationary spiral.[39] A deflationary spiral is the modern macroeconomic version of the general glut controversy of the 19th century. Another related idea is Irving Fisher's theory that excess debt can cause a continuing deflation.

Counteracting deflation Edit

During severe deflation, targeting an interest rate (the usual method of determining how much currency to create) may be ineffective, because even lowering the short-term interest rate to zero may result in a real interest rate which is too high to attract credit-worthy borrowers. In the 21st-century negative interest rate has been tried, but it cannot be too negative, since people might withdraw cash from bank accounts if they have a negative interest rate. Thus the central bank must directly set a target for the quantity of money (called "quantitative easing") and may use extraordinary methods to increase the supply of money, e.g. purchasing financial assets of a type not usually used by the central bank as reserves (such as mortgage-backed securities). Before he was Chairman of the United States Federal Reserve, Ben Bernanke claimed in 2002, "sufficient injections of money will ultimately always reverse a deflation",[40] although Japan's deflationary spiral was not broken by the amount of quantitative easing provided by the Bank of Japan.

Until the 1930s, it was commonly believed by economists that deflation would cure itself. As prices decreased, demand would naturally increase, and the economic system would correct itself without outside intervention.

This view was challenged in the 1930s during the Great Depression. Keynesian economists argued that the economic system was not self-correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending. Reserve requirements from the central bank were high compared to recent times. So were it not for redemption of currency for gold (in accordance with the gold standard), the central bank could have effectively increased money supply by simply reducing the reserve requirements and through open market operations (e.g., buying treasury bonds for cash) to offset the reduction of money supply in the private sectors due to the collapse of credit (credit is a form of money).

With the rise of monetarist ideas, the focus in fighting deflation was put on expanding demand by lowering interest rates (i.e., reducing the "cost" of money). This view has received criticism in light of the failure of accommodative policies in both Japan and the US to spur demand after stock market shocks in the early 1990s and in 2000–2002, respectively. Austrian economists worry about the inflationary impact of monetary policies on asset prices. Sustained low real rates can cause higher asset prices and excessive debt accumulation. Therefore, lowering rates may prove to be only a temporary palliative, aggravating an eventual debt deflation crisis.

Special borrowing arrangements Edit

When the central bank has lowered nominal interest rates to zero, it can no longer further stimulate demand by lowering interest rates. This is the famous liquidity trap. When deflation takes hold, it requires "special arrangements" to lend money at a zero nominal rate of interest (which could still be a very high real rate of interest, due to the negative inflation rate) in order to artificially increase the money supply.

Capital Edit

Although the values of capital assets are often casually said to deflate when they decline, this usage is not consistent with the usual definition of deflation; a more accurate description for a decrease in the value of a capital asset is economic depreciation. Another term, the accounting conventions of depreciation are standards to determine a decrease in values of capital assets when market values are not readily available or practical.

Historical examples Edit

EU countries Edit

The inflation rate of Greece was negative during three years from 2013 to 2015. The same applies to Bulgaria, Cyprus, Spain and Slovakia from 2014 to 2016. Greece, Cyprus, Spain and Slovakia are members of the European monetary union. The Bulgarian currency, the lev, is pegged to the Euro with a fixed exchange rate. In the entire European Union and the Eurozone a disinflationary development was to be observed in the years 2011 to 2015.

Year Bulgaria Greece Cyprus Spain Slovakia EU Eurozone
2011 3.4 3.1 3.5 3.0 4.1 3.1 2.7
2012 2.4 1.0 3.1 2.4 3.7 2.6 2.5
2013 0.4 −0.9 0.4 1.5 1.5 1.5 1.4
2014 −1.6 −1.4 −0.3 −0.2 −0.1 0.6 0.4
2015 −1.1 −1.1 −1.5 −0.6 −0.3 0.1 0.2
2016 −1.3 0.0 −1.2 −0.3 −0.5 0.2 0.2
2017 1.2 1.1 0.7 2.0 1.4 1.7 1.5

Table: Harmonised index of consumer prices. Annual average rate of change (%) (HICP inflation rate).[41] Negative values are highlighted in colour.

Hong Kong Edit

Following the Asian financial crisis in late 1997, Hong Kong experienced a long period of deflation which did not end until the fourth quarter of 2004.[42] Many East Asian currencies devalued following the crisis. The Hong Kong dollar, however, was pegged to the US dollar, leading to an adjustment instead by a deflation of consumer prices. The situation was worsened by the increasingly cheap exports from mainland China, and "weak consumer confidence" in Hong Kong. This deflation was accompanied by an economic slump that was more severe and prolonged than those of the surrounding countries that devalued their currencies in the wake of the Asian financial crisis.[43][44]

Ireland Edit

In February 2009, Ireland's Central Statistics Office announced that during January 2009, the country experienced deflation, with prices falling by 0.1% from the same time in 2008. This was the first time deflation has hit the Irish economy since 1960. Overall consumer prices decreased by 1.7% in the month.[45]

Brian Lenihan, Ireland's Minister for Finance, mentioned deflation in an interview with RTÉ Radio. According to RTÉ's account,[46] "Minister for Finance Brian Lenihan has said that deflation must be taken into account when Budget cuts in child benefit, public sector pay and professional fees are being considered. Mr Lenihan said month-on-month there has been a 6.6% decline in the cost of living this year."

This interview is notable in that the deflation referred to is not discernibly regarded negatively by the Minister in the interview. The Minister mentions the deflation as an item of data helpful to the arguments for a cut in certain benefits. The alleged economic harm caused by deflation is not alluded to or mentioned by this member of government. This is a notable example of deflation in the modern era being discussed by a senior financial Minister without any mention of how it might be avoided, or whether it should be.[47][original research?]

Japan Edit

Deflation started in the early 1990s.[37] 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.[48]
  • Unfavorable demographics. Japan has an aging population (22.6% over age 65) which has been declining since 2011, as the death rate exceeds the birth rate.[49][50]
  • 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).[51][52]
  • 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 as methods to speed this process and thus end the deflation.[53][54][55][56][57]
  • 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.[58][59]
  • 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.[dubious ]
  • 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.[60][61]
  • 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.[62] 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.[63] 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.[64][65]

In November 2009, Japan 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%.[66] It was not until 2014 that new economic policies laid out by Prime Minister Shinzo Abe finally allowed for significant levels of inflation to return.[67] However, the COVID-19 recession once again led to deflation in 2020, with consumer good prices quickly falling, prompting heavy government stimulus worth over 20% of GDP.[68][69][70] As a result, it is likely that deflation will remain as a long-term economic issue for Japan.[71]

United Kingdom Edit

During World War I the British pound sterling was removed from the gold standard. The motivation for this policy change was to finance World War I; one of the results was inflation, and a rise in the gold price, along with the corresponding drop in international exchange rates for the pound. When the pound was returned to the gold standard after the war it was done on the basis of the pre-war gold price, which, since it was higher than equivalent price in gold, required prices to fall to realign with the higher target value of the pound.

The UK experienced deflation of approx 10% in 1921, 14% in 1922, and 3 to 5% in the early 1930s.[72]

United States Edit

 
Annual inflation (in blue) and deflation (in green) rates in the United States since 1666
 
US CPI-U starting from 1913; Source: U.S. Department of Labor

Major deflations in the United States Edit

There have been four significant periods of deflation in the United States.

The first and most severe was during the depression in 1818–1821 when prices of agricultural commodities declined by almost 50%. A credit contraction caused by a financial crisis in England drained specie out of the U.S. The Bank of the United States also contracted its lending. The price of agricultural commodities fell by almost 50% from the high in 1815 to the low in 1821, and did not recover until the late 1830s, although to a significantly lower price level. Most damaging was the price of cotton, the U.S.'s main export. Food crop prices, which had been high because of the famine of 1816 that was caused by the year without a summer, fell after the return of normal harvests in 1818. Improved transportation, mainly from turnpikes, and to a minor extent the introduction of steamboats, significantly lowered transportation costs.[25]

The second was the depression of the late 1830s to 1843, following the Panic of 1837, when the currency in the United States contracted by about 34% with prices falling by 33%. The magnitude of this contraction is only matched by the Great Depression.[73] (See: § Historical examples of credit deflation.) This "deflation" satisfies both definitions, that of a decrease in prices and a decrease in the available quantity of money. Despite the deflation and depression, GDP rose 16% from 1839 to 1843.[73]

The third was after the Civil War, sometimes called The Great Deflation. It was possibly spurred by return to a gold standard, retiring paper money printed during the Civil War:

The Great Sag of 1873–96 could be near the top of the list. Its scope was global. It featured cost-cutting and productivity-enhancing technologies. It flummoxed the experts with its persistence, and it resisted attempts by politicians to understand it, let alone reverse it. It delivered a generation's worth of rising bond prices, as well as the usual losses to unwary creditors via defaults and early calls. Between 1875 and 1896, according to Milton Friedman, prices fell in the United States by 1.7% a year, and in Britain by 0.8% a year.

— Grant's Interest Rate Observer, 10 March 2006[74]

(Note: David A. Wells (1890) gives an account of the period and discusses the great advances in productivity which Wells argues were the cause of the deflation. The productivity gains matched the deflation.[75] Murray Rothbard (2002) gives a similar account.[76])

The fourth was in 1930–1933 when the rate of deflation was approximately 10 percent/year, part of the United States' slide into the Great Depression, where banks failed and unemployment peaked at 25%.

The deflation of the Great Depression occurred partly because there was an enormous contraction of credit (money), bankruptcies creating an environment where cash was in frantic demand, and when the Federal Reserve was supposed to accommodate that demand, it instead contracted the money supply by 30% in enforcement of its new real bills doctrine, so banks failed one by one (because they were unable to meet the sudden demand for cash – see Bank run). From the standpoint of the Fisher equation (see above), there was a simultaneous drop both in money supply (credit) and the velocity of money which was so profound that price deflation took hold despite the increases in money supply spurred by the Federal Reserve.

Minor deflations in the United States Edit

Throughout the history of the United States, inflation has approached zero and dipped below for short periods of time. This was quite common in the 19th century, and in the 20th century until the permanent abandonment of the gold standard for the Bretton Woods system in 1948. In the past 60 years, the United States has experienced deflation only two times; in 2009 with the Great Recession and in 2015, when the CPI barely broke below 0% at −0.1%.[77]

Some economists believe the United States may have experienced deflation as part of the financial crisis of 2007–2010; compare the theory of debt deflation. Consumer prices dropped 1 percent in October 2008. This was the largest one-month fall in prices in the US since at least 1947. That record was again broken in November 2008 with a 1.7% decline. In response, the Federal Reserve decided to continue cutting interest rates, down to a near-zero range as of December 16, 2008.[78]

In late 2008 and early 2009, some economists feared the US would enter a deflationary spiral. Economist Nouriel Roubini predicted that the United States would enter a deflationary recession, and coined the term "stag-deflation" to describe it.[79] It was the opposite of stagflation, which was the main fear during the spring and summer of 2008. The United States then began experiencing measurable deflation, steadily decreasing from the first measured deflation of −0.38% in March, to July's deflation rate of −2.10%. On the wage front, in October 2009 the state of Colorado announced that its state minimum wage, which was indexed to inflation, was set to be cut, which would be the first time a state had cut its minimum wage since 1938.[80]

See also Edit

Notes Edit

  1. ^ Robert J. Barro and Vittorio Grilli (1994), European Macroeconomics, chap. 8, p. 142. ISBN 0-333-57764-7
  2. ^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall. p. 343. ISBN 0-13-063085-3.
  3. ^ Harry Wallop, Harry Wallop (18 November 2008). "Deflation: why it is dangerous". The Daily Telegraph. Archived from the original on 2022-01-12. Retrieved 20 September 2016.
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References Edit

  • Nicola Acocella, The deflationary bias of exit strategies in the EMU countries, in: Review of economic conditions in Italy, 2-3: 471–93, (2011).
  • Ben S. Bernanke. Deflation: Making Sure "It" Doesn't Happen Here. USA Federal Reserve Board. 2002-11-21. Accessed: 2008-10-17. (Archived by WebCite at
  • Michael Bordo & Andrew Filardo, Deflation and monetary policy in a historical perspective: Remembering the past or being condemned to repeat it?, In: Economic Policy, October 2005, pp. 799–844.
  • Georg Erber, The Risk of Deflation in Germany and the Monetary Policy of the ECB. In: Cesifo Forum 4 (2003), 3, pp. 24–29
  • Charles Goodhart and Boris Hofmann, Deflation, credit and asset prices, In: Deflation - Current and Historical Perspectives, eds. Richard C. K. Burdekin & Pierre L. Siklos, Cambridge University Press, Cambridge, 2004.
  • International Monetary Fund, Deflation: Determinants, Risks, and Policy Options - Findings of an Independent Task Force, Washington D. C., April 30, 2003.
  • International Monetary Fund, World Economic Outlook 2006 – Globalization and Inflation, Washington D. C., April 2006.
  • Otmar Issing, The euro after four years: is there a risk of deflation?, 16th European Finance Convention, 2 December 2002, London, Europäische Zentralbank, Frankfurt am Main
  • Steven B. Kamin, Mario Marazzi & John W. Schindler, Is China "Exporting Deflation"?, International Finance Discussion Papers No. 791, Board of Governors of the Federal Reserve System, Washington D. C. January 2004.
  • Krugman, Paul (1998). "Its Baaaaack: Japan's Slump and the Return of the Liquidity Trap" (PDF). Brookings Papers on Economic Activity. 1998 (2): 137–205. doi:10.2307/2534694. JSTOR 2534694. (PDF) from the original on 2016-12-03.

External links Edit

  • (EH.Net economic history encyclopedia)
  • What is deflation and how can it be prevented? 2009-07-23 at the Wayback Machine (About.com)
  • Deflation, Free or Compulsory from Making Economic Sense by Murray N. Rothbard
  • . Archived from the original on 2008-04-10.
  • Why Are Japanese Wages So Sluggish? IMF Working paper

deflation, other, uses, disambiguation, confused, with, disinflation, slowdown, inflation, rate, economics, deflation, decrease, general, price, level, goods, services, occurs, when, inflation, rate, falls, below, negative, inflation, rate, inflation, reduces,. For other uses see Deflation disambiguation Not to be confused with Disinflation a slowdown in the inflation rate 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 Inflation reduces the value of currency over time but sudden deflation increases it This allows more goods and services to be bought than before with the same amount of currency Deflation is distinct from disinflation a slow down in the inflation rate i e when inflation declines to a lower rate but is still positive 2 Economists generally believe that a sudden deflationary shock is a problem in a modern economy because it increases the real value of debt especially if the deflation is unexpected Deflation may also aggravate recessions and lead to a deflationary spiral 3 4 5 6 7 8 9 Some economists argue that prolonged deflationary periods are related to the underlying of technological progress in an economy because as productivity increases TFP the cost of goods decreases 10 Deflation usually happens when supply is high when excess production occurs when demand is low when consumption decreases or when the money supply decreases sometimes in response to a contraction created from careless investment or a credit crunch or because of a net capital outflow from the economy 11 It can also occur due to too much competition and too little market concentration 12 better source needed Contents 1 Causes and corresponding types 1 1 Growth deflation 1 2 Bank credit deflation 1 3 Debt deflation 1 4 Money supply side deflation 1 5 Credit deflation 1 5 1 Historical examples of credit deflation 1 6 Scarcity of official money 1 7 Currency pegs and monetary unions 2 Effects 2 1 On spending and borrowing 2 2 On savings and investments 3 Compared with inflation 4 Deflationary spiral 5 Counteracting deflation 5 1 Special borrowing arrangements 5 2 Capital 6 Historical examples 6 1 EU countries 6 2 Hong Kong 6 3 Ireland 6 4 Japan 6 5 United Kingdom 6 6 United States 6 6 1 Major deflations in the United States 6 6 2 Minor deflations in the United States 7 See also 8 Notes 9 References 10 External linksCauses and corresponding types EditThis section needs additional citations for verification Please help improve this article by adding citations to reliable sources in this section Unsourced material may be challenged and removed November 2014 Learn how and when to remove this template message In the IS LM model investment and saving equilibrium liquidity preference and money supply equilibrium model deflation is caused by a shift in the supply and demand curve for goods and services This in turn can be caused by an increase in supply a fall in demand or both When prices are falling consumers have an incentive to delay purchases and consumption until prices fall further which in turn reduces overall economic activity When purchases are delayed productive capacity is idled and investment falls leading to further reductions in aggregate demand This is the deflationary spiral The way to reverse this quickly would be to introduce an economic stimulus The government could increase productive spending on things like infrastructure or the central bank could start expanding the money supply Deflation is also related to risk aversion where investors and buyers will start hoarding money because its value is now increasing over time 13 This can produce a liquidity trap or it may lead to shortages that entice investments yielding more jobs and commodity production A central bank cannot normally charge negative interest for money and even charging zero interest often produces less stimulative effect than slightly higher rates of interest In a closed economy this is because charging zero interest also means having zero return on government securities or even negative return on short maturities In an open economy it creates a carry trade and devalues the currency A devalued currency produces higher prices for imports without necessarily stimulating exports to a like degree Deflation is the natural condition of economies when the supply of money is fixed or does not grow as quickly as population and the economy When this happens the available amount of hard currency per person falls in effect making money more scarce and consequently the purchasing power of each unit of currency increases Deflation also occurs when improvements in production efficiency lower the overall price of goods Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods When this happens consumers pay less for those goods and consequently deflation has occurred since purchasing power has increased Rising productivity and reduced transportation cost created structural deflation during the accelerated productivity era from 1870 to 1900 but there was mild inflation for about a decade before the establishment of the Federal Reserve in 1913 14 There was inflation during World War I but deflation returned again after the war and during the 1930s depression Most nations abandoned the gold standard in the 1930s so that there is less reason to expect deflation aside from the collapse of speculative asset classes under a fiat monetary system with low productivity growth nbsp Inflation Deflation M2 money supply increases year yearIn mainstream economics deflation may be caused by a combination of the supply and demand for goods and the supply and demand for money specifically the supply of money going down and the supply of goods going up Historic episodes of deflation have often been associated with the supply of goods going up due to increased productivity without an increase in the supply of money or as with the Great Depression and possibly Japan in the early 1990s the demand for goods going down combined with a decrease in the money supply Studies of the Great Depression by Ben Bernanke have indicated that in response to decreased demand the Federal Reserve of the time decreased the money supply hence contributing to deflation Causes include on the demand side Growth deflation HoardingAnd on the supply side Bank credit deflation Debt deflation Money supply side decision Credit deflationGrowth deflation Edit Growth deflation is an enduring decrease in the real cost of goods and services as the result of technological progress accompanied by competitive price cuts resulting in an increase in aggregate demand 15 A structural deflation existed from the 1870s until the cycle upswing that started in 1895 The deflation was caused by the decrease in the production and distribution costs of goods It resulted in competitive price cuts when markets were oversupplied The mild inflation after 1895 was attributed to the increase in gold supply that had been occurring for decades 16 There was a sharp rise in prices during World War I but deflation returned at the war s end By contrast under a fiat monetary system there was high productivity growth from the end of World War II until the 1960s but no deflation 17 Historically not all episodes of deflation correspond with periods of poor economic growth 18 Productivity and deflation are discussed in a 1940 study by the Brookings Institution that gives productivity by major US industries from 1919 to 1939 along with real and nominal wages Persistent deflation was clearly understood as being the result of the enormous gains in productivity of the period 19 By the late 1920s most goods were over supplied which contributed to high unemployment during the Great Depression 20 Bank credit deflation Edit Bank credit deflation is a decrease in the bank credit supply due to bank failures or increased perceived risk of defaults by private entities or a contraction of the money supply by the central bank 21 Debt deflation Edit Main article Debt deflation Debt deflation is a complicated phenomenon associated with the end of long term credit cycles It was proposed as a theory by Irving Fisher 1933 to explain the deflation of the Great Depression 22 Money supply side deflation Edit From a monetarist perspective deflation is caused primarily by a reduction in the velocity of money and or the amount of money supply per person A historical analysis of money velocity and monetary base shows an inverse correlation for a given percentage decrease in the monetary base the result is a nearly equal percentage increase in money velocity 13 This is to be expected because monetary base MB velocity of base money VB price level P and real output Y are related by definition MBV B PY 23 However the monetary base is a much narrower definition of money than M2 money supply Additionally the velocity of the monetary base is interest rate sensitive the highest velocity being at the highest interest rates 13 In the early history of the United States there was no national currency and an insufficient supply of coinage 24 Banknotes were the majority of the money in circulation During financial crises many banks failed and their notes became worthless Also banknotes were discounted relative to gold and silver the discount depended on the financial strength of the bank 25 In recent years changes in the money supply have historically taken a long time to show up in the price level with a rule of thumb lag of at least 18 months More recently Alan Greenspan cited the time lag as taking between 12 and 13 quarters 26 full citation needed Bonds equities and commodities have been suggested as reservoirs for buffering changes in the money supply 27 Credit deflation Edit In modern credit based economies deflation may be caused by the central bank initiating higher interest rates i e to control inflation thereby possibly popping an asset bubble In a credit based economy a slow down or fall in lending leads to less money in circulation with a further sharp fall in money supply as confidence reduces and velocity weakens with a consequent sharp fall off in demand for employment or goods The fall in demand causes a fall in prices as a supply glut develops This becomes a deflationary spiral when prices fall below the costs of financing production or repaying debt levels incurred at the prior price level Businesses unable to make enough profit no matter how low they set prices are then liquidated Banks get assets that have fallen dramatically in value since their mortgage loan was made and if they sell those assets they further glut supply which only exacerbates the situation To slow or halt the deflationary spiral banks will often withhold collecting on non performing loans as in Japan and most recently America and Spain This is often no more than a stop gap measure because they must then restrict credit since they do not have money to lend which further reduces demand and so on Historical examples of credit deflation Edit In the early economic history of the United States cycles of inflation and deflation correlated with capital flows between regions with money being loaned from the financial center in the Northeast to the commodity producing regions of the mid West and South In a procyclical manner prices of commodities rose when capital was flowing in that is when banks were willing to lend and fell in the depression years of 1818 and 1839 when banks called in loans 28 Also there was no national paper currency at the time and there was a scarcity of coins Most money circulated as banknotes which typically sold at a discount according to distance from the issuing bank and the bank s perceived financial strength When banks failed their notes were redeemed for bank reserves which often did not result in payment at par value and sometimes the notes became worthless Notes of weak surviving banks traded at steep discounts 24 25 During the Great Depression people who owed money to a bank whose deposits had been frozen would sometimes buy bank books deposits of other people at the bank at a discount and use them to pay off their debt at par value 29 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 14 25 28 These deflationary periods preceded the establishment of the U S Federal Reserve System and its active management of monetary matters Episodes of deflation have been rare and brief since the Federal Reserve was created a notable exception being the Great Depression while U S economic progress has been unprecedented A financial crisis in England in 1818 caused banks to call in loans and curtail new lending draining specie out of the U S citation needed The Bank of the United States also reduced its lending Prices for cotton and tobacco fell The price of agricultural commodities also was pressured by a return of normal harvests following 1816 the year without a summer that caused large scale famine and high agricultural prices 30 There were several causes of the deflation of the severe depression of 1839 1843 which included an oversupply of agricultural commodities importantly cotton as new cropland came into production following large federal land sales a few years earlier banks requiring payment in gold or silver the failure of several banks default by several states on their bonds and British banks cutting back on specie flow to the U S 28 31 This cycle has been traced out on a broad scale during the Great Depression Partly because of overcapacity and market saturation and partly as a result of the Smoot Hawley Tariff Act international trade contracted sharply severely reducing demand for goods thereby idling a great deal of capacity and setting off a string of bank failures 20 A similar situation in Japan beginning with the stock and real estate market collapse in the early 1990s was arrested by the Japanese government preventing the collapse of most banks and taking over direct control of several in the worst condition Scarcity of official money Edit The United States had no national paper money until 1862 greenbacks used to fund the Civil War but these notes were discounted to gold until 1877 There was also a shortage of U S minted coins Foreign coins such as Mexican silver were commonly used 24 At times banknotes were as much as 80 of currency in circulation before the Civil War In the financial crises of 1818 19 and 1837 1841 many banks failed leaving their money to be redeemed below par value from reserves Sometimes the notes became worthless and the notes of weak surviving banks were heavily discounted 25 The Jackson administration opened branch mints which over time increased the supply of coins Following the 1848 finding of gold in the Sierra Nevada enough gold came to market to devalue gold relative to silver To equalize the value of the two metals in coinage the US mint slightly reduced the silver content of new coinage in 1853 24 When structural deflation appeared in the years following 1870 a common explanation given by various government inquiry committees was a scarcity of gold and silver although they usually mentioned the changes in industry and trade we now call productivity However David A Wells 1890 notes that the U S money supply during the period 1879 1889 actually rose 60 the increase being in gold and silver which rose against the percentage of national bank and legal tender notes Furthermore Wells argued that the deflation only lowered the cost of goods that benefited from recent improved methods of manufacturing and transportation Goods produced by craftsmen did not decrease in price nor did many services and the cost of labor actually increased Also deflation did not occur in countries that did not have modern manufacturing transportation and communications 14 By the end of the 19th century deflation ended and turned to mild inflation William Stanley Jevons predicted rising gold supply would cause inflation decades before it actually did Irving Fisher blamed the worldwide inflation of the pre WWI years on rising gold supply 32 In economies with an unstable currency barter and other alternate currency arrangements such as dollarization are common and therefore when the official money becomes scarce or unusually unreliable commerce can still continue e g most recently in Zimbabwe Since in such economies the central government is often unable even if it were willing to adequately control the internal economy there is no pressing need for individuals to acquire official currency except to pay for imported goods Currency pegs and monetary unions Edit If a country pegs its currency to one of another country that features a higher productivity growth or a more favourable unit cost development it must to maintain its competitiveness either become equally more productive or lower its factor prices e g wages Cutting factor prices fosters deflation Monetary unions have a similar effect to currency pegs Effects EditThis section needs additional citations for verification Please help improve this article by adding citations to reliable sources in this section Unsourced material may be challenged and removed Find sources Deflation news newspapers books scholar JSTOR September 2022 Learn how and when to remove this template message On spending and borrowing Edit Some believe that in the absence of large amounts of debt deflation would be a welcome effect because the lowering of prices increases purchasing power 33 However while an increase in the purchasing power of one s money benefits some it amplifies the sting of debt for others after a period of deflation the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred Consequently deflation can be thought of as an effective increase in a loan s interest rate If as during the Great Depression in the United States deflation averages 10 per year even an interest free loan is unattractive as it must be repaid with money worth 10 more each year Under normal conditions most central banks such as the Federal Reserve implement policy by setting a target for a short term interest rate the overnight federal funds rate in the U S and enforcing that target by buying and selling securities in open capital markets When the short term interest rate hits zero the central bank can no longer ease policy by lowering its usual interest rate target With interest rates near zero debt relief becomes an increasingly important tool in managing deflation In recent times as loan terms have grown in length and loan financing or leveraging is common among many types of investments the costs of deflation to borrowers has grown larger On savings and investments Edit Deflation can discourage private investment because there is reduced expectations on future profits when future prices are lower Consequently with reduced private investments spiraling deflation can cause a collapse in aggregate demand Without the hidden risk of inflation it may become more prudent for institutions to hold on to money and not to spend or invest it burying money They are therefore rewarded by saving and holding money This hoarding behavior is seen as undesirable by most economists citation needed Friedrich Hayek a libertarian Austrian school economist wrote that It is agreed that hoarding money whether in cash or in idle balances is deflationary in its effects No one thinks that deflation is in itself desirable Hayek 1932 34 Compared with inflation EditDeflation causes a transfer of wealth from borrowers and holders of illiquid assets to the benefit of savers and of holders of liquid assets and currency and because confused price signals cause malinvestment in the form of underinvestment In this sense its effects are the opposite of inflation the effect of which is to transfer wealth from currency holders and lenders savers and to borrowers including governments and cause overinvestment Whereas inflation encourages short term consumption and can similarly overstimulate investment in projects that may not be worthwhile in real terms for example the dot com and housing bubbles deflation reduces investment even when there is a real world demand not being met In modern economies deflation is usually associated with economic depression as occurred in the Great Depression and the Long Depression Deflation was present during most economic depressions in US history 35 better source needed Deflationary spiral EditA deflationary spiral is a situation where decreases in the price level lead to lower production which in turn leads to lower wages and demand which leads to further decreases in the price level 36 37 Since reductions in general price level are called deflation a deflationary spiral occurs when reductions in price lead to a vicious circle where a problem exacerbates its own cause 38 In science this effect is also known as a positive feedback loop Another economic example of this situation in economics is the bank run The Great Depression was regarded by some as a deflationary spiral 39 A deflationary spiral is the modern macroeconomic version of the general glut controversy of the 19th century Another related idea is Irving Fisher s theory that excess debt can cause a continuing deflation Counteracting deflation EditDuring severe deflation targeting an interest rate the usual method of determining how much currency to create may be ineffective because even lowering the short term interest rate to zero may result in a real interest rate which is too high to attract credit worthy borrowers In the 21st century negative interest rate has been tried but it cannot be too negative since people might withdraw cash from bank accounts if they have a negative interest rate Thus the central bank must directly set a target for the quantity of money called quantitative easing and may use extraordinary methods to increase the supply of money e g purchasing financial assets of a type not usually used by the central bank as reserves such as mortgage backed securities Before he was Chairman of the United States Federal Reserve Ben Bernanke claimed in 2002 sufficient injections of money will ultimately always reverse a deflation 40 although Japan s deflationary spiral was not broken by the amount of quantitative easing provided by the Bank of Japan Until the 1930s it was commonly believed by economists that deflation would cure itself As prices decreased demand would naturally increase and the economic system would correct itself without outside intervention This view was challenged in the 1930s during the Great Depression Keynesian economists argued that the economic system was not self correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending Reserve requirements from the central bank were high compared to recent times So were it not for redemption of currency for gold in accordance with the gold standard the central bank could have effectively increased money supply by simply reducing the reserve requirements and through open market operations e g buying treasury bonds for cash to offset the reduction of money supply in the private sectors due to the collapse of credit credit is a form of money With the rise of monetarist ideas the focus in fighting deflation was put on expanding demand by lowering interest rates i e reducing the cost of money This view has received criticism in light of the failure of accommodative policies in both Japan and the US to spur demand after stock market shocks in the early 1990s and in 2000 2002 respectively Austrian economists worry about the inflationary impact of monetary policies on asset prices Sustained low real rates can cause higher asset prices and excessive debt accumulation Therefore lowering rates may prove to be only a temporary palliative aggravating an eventual debt deflation crisis Special borrowing arrangements Edit When the central bank has lowered nominal interest rates to zero it can no longer further stimulate demand by lowering interest rates This is the famous liquidity trap When deflation takes hold it requires special arrangements to lend money at a zero nominal rate of interest which could still be a very high real rate of interest due to the negative inflation rate in order to artificially increase the money supply Capital Edit Although the values of capital assets are often casually said to deflate when they decline this usage is not consistent with the usual definition of deflation a more accurate description for a decrease in the value of a capital asset is economic depreciation Another term the accounting conventions of depreciation are standards to determine a decrease in values of capital assets when market values are not readily available or practical Historical examples EditEU countries Edit The inflation rate of Greece was negative during three years from 2013 to 2015 The same applies to Bulgaria Cyprus Spain and Slovakia from 2014 to 2016 Greece Cyprus Spain and Slovakia are members of the European monetary union The Bulgarian currency the lev is pegged to the Euro with a fixed exchange rate In the entire European Union and the Eurozone a disinflationary development was to be observed in the years 2011 to 2015 Year Bulgaria Greece Cyprus Spain Slovakia EU Eurozone2011 3 4 3 1 3 5 3 0 4 1 3 1 2 72012 2 4 1 0 3 1 2 4 3 7 2 6 2 52013 0 4 0 9 0 4 1 5 1 5 1 5 1 42014 1 6 1 4 0 3 0 2 0 1 0 6 0 42015 1 1 1 1 1 5 0 6 0 3 0 1 0 22016 1 3 0 0 1 2 0 3 0 5 0 2 0 22017 1 2 1 1 0 7 2 0 1 4 1 7 1 5Table Harmonised index of consumer prices Annual average rate of change HICP inflation rate 41 Negative values are highlighted in colour Hong Kong Edit Following the Asian financial crisis in late 1997 Hong Kong experienced a long period of deflation which did not end until the fourth quarter of 2004 42 Many East Asian currencies devalued following the crisis The Hong Kong dollar however was pegged to the US dollar leading to an adjustment instead by a deflation of consumer prices The situation was worsened by the increasingly cheap exports from mainland China and weak consumer confidence in Hong Kong This deflation was accompanied by an economic slump that was more severe and prolonged than those of the surrounding countries that devalued their currencies in the wake of the Asian financial crisis 43 44 Ireland Edit In February 2009 Ireland s Central Statistics Office announced that during January 2009 the country experienced deflation with prices falling by 0 1 from the same time in 2008 This was the first time deflation has hit the Irish economy since 1960 Overall consumer prices decreased by 1 7 in the month 45 Brian Lenihan Ireland s Minister for Finance mentioned deflation in an interview with RTE Radio According to RTE s account 46 Minister for Finance Brian Lenihan has said that deflation must be taken into account when Budget cuts in child benefit public sector pay and professional fees are being considered Mr Lenihan said month on month there has been a 6 6 decline in the cost of living this year This interview is notable in that the deflation referred to is not discernibly regarded negatively by the Minister in the interview The Minister mentions the deflation as an item of data helpful to the arguments for a cut in certain benefits The alleged economic harm caused by deflation is not alluded to or mentioned by this member of government This is a notable example of deflation in the modern era being discussed by a senior financial Minister without any mention of how it might be avoided or whether it should be 47 original research Japan Edit This section needs additional citations for verification Please help improve this article by adding citations to reliable sources in this section Unsourced material may be challenged and removed September 2010 Learn how and when to remove this template message Deflation started in the early 1990s 37 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 48 Unfavorable demographics Japan has an aging population 22 6 over age 65 which has been declining since 2011 as the death rate exceeds the birth rate 49 50 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 51 52 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 as methods to speed this process and thus end the deflation 53 54 55 56 57 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 58 59 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 dubious discuss 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 60 61 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 62 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 63 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 64 65 In November 2009 Japan 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 66 It was not until 2014 that new economic policies laid out by Prime Minister Shinzo Abe finally allowed for significant levels of inflation to return 67 However the COVID 19 recession once again led to deflation in 2020 with consumer good prices quickly falling prompting heavy government stimulus worth over 20 of GDP 68 69 70 As a result it is likely that deflation will remain as a long term economic issue for Japan 71 United Kingdom Edit During World War I the British pound sterling was removed from the gold standard The motivation for this policy change was to finance World War I one of the results was inflation and a rise in the gold price along with the corresponding drop in international exchange rates for the pound When the pound was returned to the gold standard after the war it was done on the basis of the pre war gold price which since it was higher than equivalent price in gold required prices to fall to realign with the higher target value of the pound The UK experienced deflation of approx 10 in 1921 14 in 1922 and 3 to 5 in the early 1930s 72 United States Edit nbsp Annual inflation in blue and deflation in green rates in the United States since 1666 nbsp US CPI U starting from 1913 Source U S Department of LaborMajor deflations in the United States Edit There have been four significant periods of deflation in the United States The first and most severe was during the depression in 1818 1821 when prices of agricultural commodities declined by almost 50 A credit contraction caused by a financial crisis in England drained specie out of the U S The Bank of the United States also contracted its lending The price of agricultural commodities fell by almost 50 from the high in 1815 to the low in 1821 and did not recover until the late 1830s although to a significantly lower price level Most damaging was the price of cotton the U S s main export Food crop prices which had been high because of the famine of 1816 that was caused by the year without a summer fell after the return of normal harvests in 1818 Improved transportation mainly from turnpikes and to a minor extent the introduction of steamboats significantly lowered transportation costs 25 The second was the depression of the late 1830s to 1843 following the Panic of 1837 when the currency in the United States contracted by about 34 with prices falling by 33 The magnitude of this contraction is only matched by the Great Depression 73 See Historical examples of credit deflation This deflation satisfies both definitions that of a decrease in prices and a decrease in the available quantity of money Despite the deflation and depression GDP rose 16 from 1839 to 1843 73 The third was after the Civil War sometimes called The Great Deflation It was possibly spurred by return to a gold standard retiring paper money printed during the Civil War The Great Sag of 1873 96 could be near the top of the list Its scope was global It featured cost cutting and productivity enhancing technologies It flummoxed the experts with its persistence and it resisted attempts by politicians to understand it let alone reverse it It delivered a generation s worth of rising bond prices as well as the usual losses to unwary creditors via defaults and early calls Between 1875 and 1896 according to Milton Friedman prices fell in the United States by 1 7 a year and in Britain by 0 8 a year Grant s Interest Rate Observer 10 March 2006 74 Note David A Wells 1890 gives an account of the period and discusses the great advances in productivity which Wells argues were the cause of the deflation The productivity gains matched the deflation 75 Murray Rothbard 2002 gives a similar account 76 The fourth was in 1930 1933 when the rate of deflation was approximately 10 percent year part of the United States slide into the Great Depression where banks failed and unemployment peaked at 25 The deflation of the Great Depression occurred partly because there was an enormous contraction of credit money bankruptcies creating an environment where cash was in frantic demand and when the Federal Reserve was supposed to accommodate that demand it instead contracted the money supply by 30 in enforcement of its new real bills doctrine so banks failed one by one because they were unable to meet the sudden demand for cash see Bank run From the standpoint of the Fisher equation see above there was a simultaneous drop both in money supply credit and the velocity of money which was so profound that price deflation took hold despite the increases in money supply spurred by the Federal Reserve Minor deflations in the United States Edit Throughout the history of the United States inflation has approached zero and dipped below for short periods of time This was quite common in the 19th century and in the 20th century until the permanent abandonment of the gold standard for the Bretton Woods system in 1948 In the past 60 years the United States has experienced deflation only two times in 2009 with the Great Recession and in 2015 when the CPI barely broke below 0 at 0 1 77 Some economists believe the United States may have experienced deflation as part of the financial crisis of 2007 2010 compare the theory of debt deflation Consumer prices dropped 1 percent in October 2008 This was the largest one month fall in prices in the US since at least 1947 That record was again broken in November 2008 with a 1 7 decline In response the Federal Reserve decided to continue cutting interest rates down to a near zero range as of December 16 2008 78 In late 2008 and early 2009 some economists feared the US would enter a deflationary spiral Economist Nouriel Roubini predicted that the United States would enter a deflationary recession and coined the term stag deflation to describe it 79 It was the opposite of stagflation which was the main fear during the spring and summer of 2008 The United States then began experiencing measurable deflation steadily decreasing from the first measured deflation of 0 38 in March to July s deflation rate of 2 10 On the wage front in October 2009 the state of Colorado announced that its state minimum wage which was indexed to inflation was set to be cut which would be the first time a state had cut its minimum wage since 1938 80 See also EditCauses of the Great Depression Debt deflation Degrowth Depopulation Economic inequality Glut Great Contraction Kondratiev wave UnderconsumptionNotes Edit Robert J Barro and Vittorio Grilli 1994 European Macroeconomics chap 8 p 142 ISBN 0 333 57764 7 O Sullivan Arthur Sheffrin Steven M 2003 Economics Principles in Action Upper Saddle River New Jersey Pearson Prentice Hall p 343 ISBN 0 13 063085 3 Harry Wallop Harry Wallop 18 November 2008 Deflation why it is dangerous The Daily Telegraph Archived from the original on 2022 01 12 Retrieved 20 September 2016 The Economist explains Why deflation is bad Economist Economist magazine 7 Jan 2015 Retrieved 20 September 2016 Krugman Paul 2 August 2010 Why is Deflation Bad The New York Times Retrieved 20 September 2016 Walker Andrew 29 January 2016 Is deflation such a bad thing BBC Retrieved 20 September 2016 Thoma Mark 8 April 2014 Explainer Why is deflation so harmful Moneywatch CBS Retrieved 20 September 2016 Hummel Jeffrey Rogers Death and Taxes Including Inflation the Public versus Economists January 2007 1 Archived 2009 03 25 at the Wayback Machine Blanchard O Dell Ariccia G Mauro P 18 August 2010 Rethinking macroeconomic policy Journal of Money Credit and Banking 42 1 199 215 CiteSeerX 10 1 1 153 7293 doi 10 1111 j 1538 4616 2010 00334 x S2CID 14824203 Bordo Michael D Filardo Andrew J 2005 11 01 Deflation in a Historical Perspective Rochester NY doi 10 2139 ssrn 860404 S2CID 153344185 SSRN 860404 a href Template Cite journal html title Template Cite journal cite journal a Cite journal requires journal help What Causes Negative Inflation Deflation Market Models Pure Competition Monopolistic Competition Oligopoly and Pure Monopoly a b c Hussman John O 2010 Bernanke Leaps into a Liquidity Trap a b c Wells David A 1890 Money supply Recent Economic Changes and Their Effect on Production and Distribution of Wealth and Well Being of Society New York D Appleton and Co p 222 ISBN 0 543 72474 3 Beckworth David Aggregate Supply Driven Deflation and Its Implications for Macroeconomic Stability PDF Cato Journal Cato Institute 28 3 Archived from the original PDF on 2011 10 09 Stapleford Thomas 2009 The Cost of Living in America A Political History of Economic Statistics 1880 2000 Cambridge University Peess pp 69 73 Kendrick John 1991 U S Productivity Performance in Perspective Business Economics October 1 1991 a href Template Cite journal html title Template Cite journal cite journal a Cite journal requires journal help Andrew Atkeson and Patrick J Kehoe of the Federal Reserve Bank of Minneapolis Deflation and Depression Is There an Empirical Link Archived 2016 05 06 at the Wayback Machine Bell Spurgeon 1940 Productivity Wages and National Income The Institute of Economics of the Brookings Institution Waverly press a b Beaudreau Bernard C 1996 Mass Production the Stock Market Crash and the Great Depression New York Lincoln Shanghi Authors Choice Press Carapella Francesca 2015 Banking panics and deflation in dynamic general equilibrium Finance and Economics Discussion Series 2015 018 Washington Board of Governors of the Federal Reserve System doi 10 17016 FEDS 2015 018 The Debt Deflation Theory of Great Depressions Fraser St Louis Missouri Federal Reserve October 1933 Friedman Milton 1994 Money Mischief Episodes in Monetary History Houghton Mifflin Harcourt p 38 ISBN 9780547542225 a b c d Ginsburg David 2006 Gold Coins of the New Orleans Mint How Gold Coins Circulated in 19th Century America Zyrus Press pp 25 33 ISBN 9780974237169 a b c d e Taylor George Rogers 1951 The Transportation Revolution 1815 1860 The Economic History of the United States Vol IV New York Rinehart amp Co pp 133 331 334 ISBN 978 0 87332 101 3 Greenspan interview on CNBC 3 December 2010 Browne Harry 1981 You Can Profit from a Monetary Crisis Ishi Press International ISBN 4 87187 322 6 a b c North Douglas C 1966 The Economic Growth of the United States 1790 1860 New York London W W Norton amp Company ISBN 978 0 393 00346 8 Benjamin Roth ed James Ledbetter and Daniel B Roth The Great Depression A Diary Perseus Books 2009 p 36 A market for buying bank passbooks also cropped up in places like Youngstown If you were desperate enough in 1931 for money to buy basic necessities you could get 60 to 70 cents on the dollar for your passbooks value Local newspapers even printed the weekly rates for buying and selling these passbooks as they became a commodity Roth pasted one such rate chart into his diary Taylor 1951 pp 336 Wallis Hohn Joseph National Bureau of Economic Research The Depression of 1839 to 1843 PDF Stapleford Thomas 2009 The Cost of Living in America A Political History of Economic Statistics 1880 2000 Cambridge University Press pp 69 73 Selgin George 1997 Less Than Zero The Case for a Falling Price Level in a Growing Economy PDF IEA Hobart Paper London Institute of Economic Affairs 32 87 ISSN 0073 2818 Retrieved 4 December 2014 Hayek s 1932 Letter on the Great Depression But Now You Know 25 November 2010 The History of Economic Downturns in the US But Now You Know 6 December 2008 DEFLATIONARY SPIRALS a b Grinin L E amp Korotayev A V 2018 The future of the global economy in the light of inflationary and deflationary trends and long cycles theory World Futures 74 2 84 103 Archived 2020 11 12 at the Wayback Machine Kagan Julia Deflationary Spiral Investopedia Retrieved 20 March 2021 Economics A Z terms beginning with D The Economist Deflation Making Sure It Doesn t Happen Here Archived 2008 10 24 at the Wayback Machine Remarks by Governor Ben S Bernanke before the National Economists Club Washington D C November 21 2002 Federal Reserve HICP inflation rate Eurostat Retrieved 8 February 2021 2 Archived March 8 2005 at the Wayback Machine Jao Y C 2001 Why Was Hong Kong a Laggard in Economic Recovery The Asian Financial Crisis and the Ordeal of Hong Kong Quorum Books pp 155 170 ISBN 978 1 56720 447 6 Liu Henry C K 2003 07 04 Why Hong Kong is in crisis Asia Times Archived from the original on 2003 07 08 Retrieved 27 April 2010 a href Template Cite news html title Template Cite news cite news a CS1 maint unfit URL link First annual negative inflation in 49 years RTE ie 12 February 2009 Deflation a factor in Budget cuts Lenihan Archived 2018 09 03 at the Wayback Machine RTE News 9 December 2009 RTE News Deflation a factor in Budget cuts Lenihan Archived February 26 2010 at the Wayback Machine Meet the new BOJ same as the old BOJ TheMoneyIllusion 2010 10 05 Retrieved 2013 02 14 Dooley Ben 2019 12 24 Japan Shrinks by 500 000 People as Births Fall to Lowest Number Since 1874 Published 2019 The New York Times ISSN 0362 4331 Retrieved 2021 02 04 Statistics Bureau Home Page Population Estimates Monthly Report 2019 06 06 Archived from the original on 2019 06 06 Retrieved 2021 02 04 Nielsen Barry The Lost Decade Lessons From Japan s Real Estate Crisis Investopedia Retrieved 2021 02 04 Post The Blah 2019 11 17 Japanese Asset Price Bubble Medium Retrieved 2021 02 04 Group Global Legal International Comparative Legal Guides International Comparative Legal Guides International Business Reports Retrieved 2021 02 04 Practical Law UK Signon signon thomsonreuters com Retrieved 2021 02 04 Japan s 2020 corporate bankruptcies fall to 31 year low with government aid The Japan Times 2021 01 13 Retrieved 2021 02 04 Prize possessions The Economist 2002 05 09 ISSN 0013 0613 Retrieved 2021 02 04 What to do about zombie firms The Economist 2020 09 24 ISSN 0013 0613 Retrieved 2021 02 04 Is the Bank of Japan Technically Insolvent Dangers Involved in Long Term Deterioration of BoJ Financial Position Discuss Japan Japan Foreign Policy Forum www japanpolicyforum jp Archived from the original on 2021 02 09 Retrieved 2021 02 04 Nippon Credit Bank declared insolvent and nationalised The Irish Times Retrieved 2021 02 04 PDF https www frbsf org economic research files wp08 29bk pdf Archived PDF from the original on 2014 03 08 a href Template Cite web html title Template Cite web cite web a Missing or empty title help New Japanese Import Deflation www bullionvault com Retrieved 2021 02 04 Why Stimulus Spending Depresses the Economy But Now You Know 16 July 2009 Explaining Japan s Recession Benjamin Powell Mises Institute 19 November 2002 Ponciano Jonathan World Bank Warns Stimulus Spending And Dangerous Debt Crisis Could Trigger Recession And Wipe Out A Decade Of Income Gains Forbes Retrieved 2021 02 04 Salsman Richard Japan s Three Decades of Depressive Stimulus Schemes AIER www aier org Retrieved 2021 02 04 Japan Releases Stimulus Package as Recovery Weakens Update3 Bloomberg News 16 August 2023 Japan inflation rate hits 23 year high BBC News 2014 05 30 Retrieved 2021 02 04 Abe unveils massive coronavirus stimulus worth 20 of GDP The Japan Times 2020 04 06 Retrieved 2021 02 04 Kihara Kaori Kaneko Leika 2020 12 18 Japan s consumer prices fall at fastest pace in decade stoke deflation fears Reuters Retrieved 2021 02 04 a href Template Cite news html title Template Cite news cite news a CS1 maint multiple names authors list link Deflation fears reignited as pandemic hits consumer prices in Japan The Japan Times 2020 05 01 Retrieved 2021 02 04 FocusEconomics Japan Inflation Rate CPI Japan Economy Forecast amp Outlook FocusEconomics Economic Forecasts from the World s Leading Economists Retrieved 2021 02 04 Bank of England Quarterly inflation report Feb 2009 p 33 chart A a b Atack Jeremy Passell Peter 1994 A New Economic View of American History New York W W Norton and Co p 102 ISBN 0 393 96315 2 Inflation ho a primer on deflation Grant s Interest Rate Observer 23 May 2003 Archived from the original on 28 February 2006 Wells David A 1890 Recent Economic Changes and Their Effect on Production and Distribution of Wealth and Well Being of Society New York D Appleton and Co ISBN 0 543 72474 3 Rothbard Murray 2002 History of Money and Banking in the United States Ludwig Von Mises Institute pp 164 8 ISBN 0 945466 33 1 Rosenberg Yuval 26 February 2015 America Is In Deflation So What The Fiscal Times FOMC statement Press release Board of Governors of the Federal Reserve System 16 December 2008 Roubini Nouriel 30 October 2008 Get Ready For Stag Deflation Forbes Svaldi Aldo 13 October 2009 Colorado minimum wage set to fall The Denver Post References EditNicola Acocella The deflationary bias of exit strategies in the EMU countries in Review of economic conditions in Italy 2 3 471 93 2011 Ben S Bernanke Deflation Making Sure It Doesn t Happen Here USA Federal Reserve Board 2002 11 21 Accessed 2008 10 17 Archived by WebCite at https web archive org web 20081024060408 http www federalreserve gov BOARDDOCS SPEECHES 2002 20021121 default htm Michael Bordo amp Andrew Filardo Deflation and monetary policy in a historical perspective Remembering the past or being condemned to repeat it In Economic Policy October 2005 pp 799 844 Georg Erber The Risk of Deflation in Germany and the Monetary Policy of the ECB In Cesifo Forum 4 2003 3 pp 24 29 Charles Goodhart and Boris Hofmann Deflation credit and asset prices In Deflation Current and Historical Perspectives eds Richard C K Burdekin amp Pierre L Siklos Cambridge University Press Cambridge 2004 International Monetary Fund Deflation Determinants Risks and Policy Options Findings of an Independent Task Force Washington D C April 30 2003 International Monetary Fund World Economic Outlook 2006 Globalization and Inflation Washington D C April 2006 Otmar Issing The euro after four years is there a risk of deflation 16th European Finance Convention 2 December 2002 London Europaische Zentralbank Frankfurt am Main Steven B Kamin Mario Marazzi amp John W Schindler Is China Exporting Deflation International Finance Discussion Papers No 791 Board of Governors of the Federal Reserve System Washington D C January 2004 Krugman Paul 1998 Its Baaaaack Japan s Slump and the Return of the Liquidity Trap PDF Brookings Papers on Economic Activity 1998 2 137 205 doi 10 2307 2534694 JSTOR 2534694 Archived PDF from the original on 2016 12 03 External links Edit nbsp Wikiquote has quotations related to Deflation Cato Policy Report A Plea for Mild Deflation Deflation EH Net economic history encyclopedia What is deflation and how can it be prevented Archived 2009 07 23 at the Wayback Machine About com Deflation Free or Compulsory from Making Economic Sense by Murray N Rothbard Annual Inflation Rate Japan Archived from the original on 2008 04 10 Why Are Japanese Wages So Sluggish IMF Working paper Retrieved from https en wikipedia org w index php title Deflation amp oldid 1179573371 Deflationary spiral, wikipedia, wiki, 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