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The Impacts of Inflation and the Possibility of Deflation
The impact of inflation can now be felt by everyone, with prices continually rising at a rapid pace. Despite the government’s assurances that the rate is slowing, this simply means sky-high prices are increasing at a slower pace. One realizes the true gravity of the situation when grabbing dinner – a few pizzas, salads, and garlic knots – ends up costing around $100. So, are we stuck in this situation indefinitely, or could we ever see prices decrease? The latter would only be possible if deflation was to take place.
Understanding Deflation
Deflation occurs when there is a general decrease in the prices of goods and services. This is the opposite of inflation, which erodes purchasing power while deflation increases it. However, deflation is not positive for the economy. It usually signifies looming economic distress and stagnation. To understand how deflation comes to pass involves an understanding of a mix of economic factors, policies and influences on the global scale.
What Triggers Deflation
Reduced consumer demand can cause deflation. When both consumers and businesses anticipate a drop in prices, they may put off purchases and investments, leading to an oversupply of goods and services which pushes prices down. Another potential deflation trigger is advancements in technology. Innovations and improvements in technology can increase productivity, thus lowering production costs. Monetary policy can impact deflation as well. The decisions of the Federal Reserve regarding interest rates could be part of the solution to lessen inflation. High debt levels can lead to deflation if consumer and business spending is curtailed due to repayment of debt. Lastly, global economic conditions and dynamics can have an indirect impact on deflation. Should a global recession or slowdown occur, the demand for US exports would decrease. Furthermore, cheaper imports would result in decreased domestic prices.
History of Deflation
Historically, deflation has proven significantly distressing. An example is the The Great Depression of the 1930s, a period when the United States experienced severe deflation, with a sharp price drop of nearly 30%. Another example can be seen in Japan during the 1990s, coined the “Lost Decade”, providing a clear example of how extended deflation periods may hamper economic growth.
How Deflation Could Occur in Today’s Scenario
There could be several potential triggers to deflation, including shifts in the economy post-pandemic. Government spending and economic support prompted by the COVID-19 pandemic was unprecedented and the withdrawal of these could lead to reduced consumer and business spending. Similarly, if the Federal Reserve and other policy makers make errors in assessing economic conditions and execute monetary policy too strictly, it could inadvertently ignite deflation. Ongoing global economic instability, trade tensions, or another global financial crisis could also enhance deflationary risks as a reduce in demand for U.S. exports.
The Double-edged Sword of Deflation
While deflation may appear beneficial due to lowering prices, it may have severe economic consequences, leading companies to reduce production, slash wages and dismiss employees, bringing about higher unemployment. Is this the future that we’d like to see? Furthermore, economic scenarios also suggest that deflation is rather unlikely in the near future. Thus, it’s time for everyone to brace for the new normal – a shopping bag of groceries that cost $50 on an average.
Written by Ted Jenkin, CEO and co-founder of Oxygen Financial and president of Exit Stage Left Advisors.
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