What are the negative effects of deflation

3 problematic consequences of deflation

If you are concerned with your retirement provision, a financial investment or your own salary / pension, sooner or later you will come across the term inflation.

“After deducting inflation, your purchasing power is so or so.” For example, if you take out life insurance with 2.5% interest, the return after deducting inflation is lower. But if you think that you are demonizing inflation, you would do well to look at the consequences of the opposite, to take a closer look at deflation.

The economic consequences of deflation

Deflation is defined in economics as a decline in the general price level. This means that, for example, prices of food, services, electricity, petrol, etc. are falling. What sounds like paradise to the average consumer at first has catastrophic consequences in the medium and long term.

At first you might be happy about the falling prices for milk and apples, wonder why electricity prices are getting cheaper and why a visit to the wellness hotel in the Eifel is cheaper than ever. But this is exactly where the fallacy of an alleged advantage lies. Because, as paradoxical as it may sound, falling prices are poison for an economy as we know it.

1. Consequence: Employee lay-off in order to reduce costs

Since wages and salaries are contractually regulated, they are accordingly inflexible. If a company cannot maintain its margin because prices are falling, it is forced to reduce its costs as well.

In almost every company, the largest share of costs is made up of personnel costs. This turns this screw first: Expiring contracts are not extended, probationary periods are used to terminate the contract and operational dismissals can be issued. For the state, this reduces income from wage tax.

Second consequence: more unemployed, less consumption

Due to the rise in unemployment, many people find themselves in financial difficulties and shy away from making major purchases or spending. Holidays are canceled, car repairs have to wait, etc. As a result, the revenue from value added tax, among other things, is reduced for the state budget.

The downward spiral is now moving faster and faster. Due to falling consumption, companies are selling fewer and fewer products and have to lay off more employees.

3rd consequence: waiting for even lower prices, no consumption

Deflation is now the number one issue in society. Larger purchases are being postponed as the average consumer speculates that prices will continue to fall.

For the individual this looks like an advantage at the moment, but the overall economic consequences of deflation are devastating. Consumption stagnates, corporate profits collapse, workers are laid off, and unemployment rises. Now the economic phase of recession is in full swing.

Causes of deflation and measures to combat it

There are many possible causes of deflation. For example, if the current economic situation worsens a little, people are usually more cautious and consume less. In return, more is saved and the companies earn less. The state can also contribute to deflation by massively reducing expenditure (state consumption). This creates a gap in demand and leads to a drop in prices.

A great deal of effort is required to fight deflation. Since there is a lack of demand for consumer goods and a high unemployment rate, banks must provide companies with cheap loans to stimulate investment. This requires a decision by the European Central Bank (ECB). More jobs in turn mean more wealth in the population and increasing consumption.

Everything is waiting for the FED! After that, the market can tilt. Most prices run up in the 24 hours before the Fed meeting and then they sell off because the Fed did not deliver what the market wanted. > read more

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