The term deflation refers to the general decline in the prices of goods and services in general, and financial deflation is associated with the supply of cash, savings, and insurance in the economy. When deflation occurs, the purchasing power of the currency rises over time, so that you can buy a greater number of products and services tomorrow with the same amount you have today in the event of a deflation.
What is the working principle of deflation?
Financial deflation can be interpreted as a reflection of the concept of inflation. The occurrence of deflation means that there is a sign of recession and difficult economic conditions that can occur since deflation is linked to lower prices that will lead to customers delaying purchases to be able to get the lowest prices for the same products. This means that producers and traders will not be able to sell what they have, which will reflect on their ability to continue business. This calls for reducing the number of employees and reducing the volume of basic materials used for production. Thus, unemployment rates will rise and spending will decrease, which leads the state to live another contraction within the basic contraction that suffers from it.
What are the causes of the financial deflation?
Economists believe that there are two main reasons for the occurrence of the financial deflation, which are the general decrease in the total demand for the offered goods and services, and the increase in the volume of goods and services in supply with the decrease in demand for them. Overall percentage:
The influence of the money supply
Central banks use tight monetary policies linked to raising interest rates, which affect people’s spending. Instead of spending money directly, people will prefer to save money to get higher rates of interest, which, according to economic principles, will lead to higher borrowing costs, which will be followed by a decrease in the level of public spending in the economy.
Decline in economic confidence
Negative events that occur in the economy, such as a recession, cause a decrease in the total market demand for goods and services. It is possible for people to become more pessimistic about the economic future of the state, which will push them to increase the proportion of savings and reduce public expenditures, which means that they are not encouraged to invest and make purchases. As was the case in the past, and consequently, the low demand rate and the high chances of a financial contraction in the country.
Lower production costs.
The decrease in the prices of raw materials that are used in the production of products leads to a decrease in production costs as a whole, which leads producers to increase the production rate of these products for fear of their increasing in the future, which leads to a high volume of supply in the economy, and if the demand rate does not change, producers will resort to To reduce prices to convince customers to buy these products so they do not pay high storage costs.
Technological developments
Technological developments and significant progress in the application of production techniques in the work environment and manufacturing affect the increase in the supply of goods and services in the market, so that technological means reduce the costs paid by producers in order to produce some goods and services, and it may come to enable them to reduce the number of employees and save on their wages, which means a greater possibility to raise production levels and thus lower prices for goods and services.
What are the effects of financial deflation?
Some countries may not recover from the effects of financial deflation on their economies; the following is an explanation of some of these effects:
Decreased revenue for the business.
Some companies reduce the prices of their products to maintain their competitiveness in the market, which will lead to a decrease in their revenues. Given that deflationary periods are constantly repeated, companies will become constrained to reduce prices more than once and increasingly, even if they are working hard to achieve profits, but they will keep dropping due to the relationship between price and returns.
Pay cuts and layoffs.
Revenues or returns for companies begin to decline gradually, which calls for finding ways to reduce the amount of expenses and expenses that you pay, so companies consider that the best solution to reduce these expenses is by reducing the wages of the employees who work for them, which in turn leads to an increase in deflation, which will lead to an increase in the unemployment rate, and thus the volume of public spending in the state will become less.
Changes in customer behavior and spending
The relationship between consumer spending and deflation can be viewed as a complex one that is often difficult to predict. When the economy faces deflationary periods, customers benefit from the price reductions made by companies during that period, which may seem feasible for companies during the beginning of the period so that they can achieve good profits, but after the passage of time the people who lost their jobs will begin to reduce spending and purchases, which means an increase in The financial deflation and its impact.
Get fewer stakes in the investment.
The investor takes cash reserves when he feels the danger of economic accidents, which means that he will reduce his market share in the economy because of his concern about the inability of companies to achieve profits and returns for him, so he will give up investing in the shares he owns and sell them to other people, which leads to a decline in the value of companies in the market, which means that it will directly affect the economy and negatively affect the ability of countries to continue to grow and maintain business.
How to measure deflation
Many countries resort to measuring the size of the deflation experienced by the economy, to find out how affected it is and what appropriate measures they can take to solve all the problems that trouble it, so that economists use economic indicators for that, and among these indicators:
Customer Price Index
The Price Index (CPI) tracks the prices of a group of goods and services that are important, are commonly purchased and may change in each period. Whereas, if the opposite happens, it means that the economy is suffering from inflation.
Tools to tackle the problem of financial deflation
Governments take the necessary decisions to try to solve the problem of financial deflation through the use of many tools, and the following is an explanation of the most prominent of these tools:
Reducing the size of the bank’s reserves
Some developed countries, such as the United States and others, determine the size of a specific reserve of money for banks or banks as a whole, so that banks use these deposits to create new loans in the event of any problem. Only $90 of it, while $10 is kept as a future reserve, and when deflation occurs, governments ease the percentage of these limits to work on stimulating investors and facilitating loans from them.
Negative interest rates
Based on this method, the people or entities who deposit their money in banks will not receive the interest on their deposits, but will pay interest to the banks in order to keep their money with them; In periods of economic deflation, keeping money is somewhat costly, which means supporting the economy and governments to solve the problems they face indirectly, and investing in assets and projects with positive returns.
Increasing government spending
Individuals and companies stop spending because of the crisis that countries are going through, so there will be no incentive for production and employment operations, etc., and accordingly, governments must spend to support the economy and raise its level or return it to its previous era, so that these governments lend money to spend it As it endures the financial deficit that it will suffer from until prices start to rise again.
Lower tax rates
In cases of financial deflation, governments reduce tax rates by certain percentages, which means that individuals and companies will have more money to spend, but this may constitute a decrease in the rate of government tax revenues, which may force governments to reduce spending and sometimes to stop some basic operations services .
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