This essay will seek to examine and critically analyse the consequences of deflation on a macroeconomic level. Economic theory will be drawn from to aid comprehension of deflation and its effect on the economy. Articles from Financial times will be used as case studies to better understand the practical effects of deflation. The implications and effect these have on an economy will be explored, particularly focusing on governments and business deal with deflation.
Defining Deflation
Inflation refers to the rate at which prices for goods and services rises. How is it calculated?
Deflation is a complex phenomenon however the most widely adopted definition is a “sustained fall in a weighted average of all prices” (David Bae, 2014, 47). Although accurate and concise, the definition only offers a simplistic explanation. It fails to address the causal reasons of declining prices which are required to ascertain whether the deflationary period is either harmful or benign for the economy. Deflation arises from two main causes; falling levels of aggregate demand and increase in productive potential (Horwitz, 2014, 144-145). In defining deflation, General Equilibrium Theory offers a basis on which to better appreciate the relationship it shares with the economy. Under general equilibrium theory, the aggregate supplied should equal the aggregate demanded at the current given price, enabling effective distribution of goods and services within an economy. Here, price is the equaliser and acts to balance demand and supply; when this occurs the economy is in monetary equilibrium (Levin, 2006). Through understanding basic equilibrium theory, a clearer view of how price effects aggregate supply and aggregate demand is provided. This also highligh...
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...he effect this has on the labour market. Highlighted in picture 2, the wage rate is above the market clearing equilibrium level. This shows the population wants to supply Q3 amount of labour in exchange for W2 wage rate. However businesses are unable to offer this, and respond by only hiring Q2 amount in exchange for W2 wage rate. This results in the supply of labour exceeding the demand for labour. The remaining surplus of labour is defined as real rage unemployment. Between 1929 and early 1932, Germany experienced severe real wage unemployment caused by severe deflation during the Great Depression. Consequently, Germany’s unemployment rose from little under 1.3 million to over 6 million within three years (Dimsdale et al, 2004).
DIMSDALE – http://www.economics.ox.ac.uk/materials/papers/2292/56dimsdale.pdf
https://www.imf.org/external/pubs/ft/wp/2015/wp15229.pdf
First, I will discuss the time period between 1973-1974. Because the unemployment and inflation rates are higher than normal, we can assume that the aggregate-demand curve is downward-sloping. When the aggregate-demand curve is downward-sloping, we know that the economy’s demand has slowed down. When the economy’s demand has slowed down, businesses have to choice but to raise prices and lay off workers in order to preserve profits. When employers throughout the country respond to their decrease in demand the same way, unemployment increases.
In order for Germany to pay the debt that they owed they kept changing the value of their currency. This action caused inflation. The Bourgeoisie was suffering greatly from inflation as well. Infla...
According to Reich, an economy’s stability is dependent on the prosperity of its middle class. The cause of the depression was the growing wages and money not being returned to the middle class. The Virtuous Cycle of a healthy economy occurs in 6 steps: productivity growth, wage increases, more jobs, tax revenues increase, government investments, and educated workers. A healthy economy is possible, but it is not our reality today. The two factors that led to flattening wages in the 1970s are globalization and technology.
In this section I will be discussing how inflation rates have increased over the past 40 years, and what effect this has had on monetary growth. Inflation rates are defined as the rate of change in price levels in our economy especially Canada. Surveys are conducted quarterly or monthly to determine and generate a Consumer Price Index. The CPI is conducted with a “basket of goods” to determine changes in consumer prices for Canadians. It is important to study and analyze the rate of inflation because it helps the government determine how the dollar value has changed over a period of time. Also to adjust pending contracts and initiate new pensions which have to take into account the effect of inflation. Less well-off people and elderly are more
The world economic depression, which began with the Wall Street Crash in October 1929, had a devastating effect on the German economy. Banks collapsed, prices fell and world trade contracted. Agriculture was badly affected by the fall in world trade. Foreign banks withdrew funds. To make matters worse, Heinrich Bruning (Chancellor 1930-32) adopted a deflationary economic policy to balance the Budget by cutting public expenditure.
Hyperinflation is an economic condition characterized by “a rapid increase in the overall price level that continues over a significant period” and in this period the concept of inflation is essentially rendered meaningless (Kroon 90). The post-World War I German economy experienced a crippling period of hyperinflation which lasted nearly two years and had an enormous impact on the economy. The hyperinflation began inconspicuously as the inflation rate crept just a percent or two per year during the war years. In the post-war period inflation began to rise and in early- to mid-1922, inflation raged. During this period, businesses reached full operational capacity and unemployment nearly disappeared. While nominal wages increased, real wages dropped precipitously. Workers were paid two or three times a day, and they rushed home to pass the money to family members who could go and exchange the rapidly depreciating currency for real goods (clothing, food, etc.) before it became completely worthless. Prices rose so rapidly pe...
Federal Reserve Bank of San Francisco (1999) shows that deflation is defined as an rise in the overall price level over a period of time that represented the opposite of inflation, and has been defined as “A sustained fall in the general price level.” By the MIT Dictionary of Modern Economics.
The effect of the Hyper-inflation was of sheer devastation in terms of economy. The German mark’s value decreased alarmingly within a short period of time and people literally started to burn the German mark notes just to make a fire as they thought this was of a much more bigger advantage than of its actual spending value. The rising cost for just one loaf of bread was unbelievable, in 1918 it sold at 0.63 marks, a normal price, until the end of the war hit. January 1923, a selling price of 250 marks and in the following months it rose in quick succession until in November one loaf actually cost 201,000,000,000 marks, just from this example we see the dire effects. People ended up having to take home “Daily” wages instead of weekly, with the help of a wheelbarrow. The w...
This article by Andrew McCathie posted in EarthTimes and titled “European inflation climbs unemployment at 12-year high was posted on Friday July 30 2010. The article reports that food and energy costs have played a critical role in driving up inflation in the 16-member eurozone. The rates of unemployment remained stagnant to its highest level during this time.
Inflation is the increase in the overall level of prices in the economy and deflation is just the opposite. When there is inflation, it is resulted from too much money being circulated in the economy, causing prices to hike. On the other hand, deflation is caused by the decrease in the money supply, causing decreases in prices in the long run. Inflation is a trend that we have seen more recently in the United States, but there have also been times of deflation. Inflation and deflation affect multiple groups of the economy in different ways with each situation. Both of these situations have costs for consumers and producers. Being in one situation may cause incomes and employment to fall. There is a concern with both inflation and deflation because there are
Savings accounts, the result of years of hard work, were instantly wiped out. Inflation soon followed. hard for families to purchase expensive necessities with devalued money. I will be able to make it. Overnight, the middle class standard of living so many Germans families enjoyed was ruined by events outside of Germany, beyond their control.
Inflation and unemployment are two key elements when evaluating a whole economy and it is also easy to get those figures from National Bureau of Statistics when you want to evaluate it. However, the relationship between them is a controversial topic, which has been debated by economists for decades. From some famous economists such as Paul Samuelson, Milton Freidman etc to some infamous economists, this topic received a lot of attention. However, it is this debate that makes the thinking about it evolve. In this essay, the controversial topic will be discussed by viewing different economists’ opinions on that according to time sequencing. But before started, it is worthy getting a better understanding of the terms, inflation and unemployment.
Inflation; ‘a situation in which prices rise in order to keep up with increased production costs… result[ing] [in] the purchasing power of money fall[ing]’ (Collin:101) is quickly becoming a problem for the government of the United Kingdom in these post-recession years. The economic recovery, essential to the wellbeing of the British economy, may be in jeopardy as inflation continues to rise, reducing the purchasing power of the public. This, in turn, reduces demand for goods and services, and could potentially plummet the UK back into recession. This essay discusses the causes of inflation, policy options available to the UK government and the Bank of England (the central bank of the UK responsible for monetary policy), and the effects they may potentially have on the UK recovery.
Inflation is the rate at which the purchasing power of currency is falling, consequently, the general level of prices for goods and services is rising. Central banks endeavor to point of confinement inflation, and maintain a strategic distance from collapse i.e. deflation, with a specific end goal to keep the economy running smoothly.
Inflation is one of the most important economic issues in the world. It can be defined as the price of goods and services rising over monthly or yearly. Inflation leads to a decline in the value of money, it means that we cannot buy something at a price that same as before. This situation will increase our cost of living.