Skip to main content

Problems of Deflation For The Economy


In economics, deflation is defined as a condition where there is a decrease in the price of goods and services at a certain time. At first glance, this condition seems favorable to consumers because they will be able to buy a product for their needs while also being able to save less of their expenses.

This price drop usually occurs during a recession. When the price of an item falls, this will result in the profitability of the producer decreases. When this condition runs, of course from the manufacturer or company will cut its workforce to cover existing losses while reducing its expenses. This is then the trigger of the high unemployment rate.

When unemployment increases, of course incomes from households become decreased or even have difficulties, causing their purchasing power or demand capacity to decrease. On the other hand, manufacturers will respond this situation by lowering the stock or quantity of goods offered and this condition can weaken the economy of a country.

From the above exposure, we can know that deflation has a lot to do with others while affecting various conditions. To drill down further, let's find out why this deflation could happen.

Causes and Effects of Deflation


What kind of condition creates deflation?

Price level decreases usually occur due to increased production output and decreased demand or depreciation of the amount of money in circulation.

In the law of supply, a high supply of goods and services can cause a decrease in the price of such goods due to surplus conditions. Furthermore, manufacturers will face market competition with others and force them to lower the selling price of their goods.

There are two conditions that result in oversupply from manufacturers. First, production costs are cheap. When the costs incurred to produce a production output are cheap, producers will be able to increase production output until it finally gets to the point where they are oversupplied. If this situation occurs coupled with unchanged consumer demand, manufacturers need to lower the price of their goods in order to still be purchased by consumers. Second, technological advancements. When the production factor involves an advanced technology, it can certainly make the manufacturer to produce a higher amount of production output.

Scroll to Continue

Next, decrease in demand. The decrease in the price of goods due to the decrease in demand is much more dangerous than the result of increased supply. This is because this kind of deflation can lead to sustained deflation. There are a variety of factors that make people's demand or purchasing power reduced.

First, the decrease in the amount of money circulating in the community. Central banks could create a stricter policy in which they would raise interest rates. When interest rates are high, this makes people more likely to prefer to keep their money than use it as an expense. In addition, rising interest rates also result in higher borrowing costs and of course from people reluctant to take risks in terms of spending money.

Then there's the recession. A contraction in the economy that occurs in a row can make a country fall to the brink of recession. When the recession worsens, deflation will also worsen. When this situation occurs, householders as consumers will be pessimistic about the economic activity that occurred at that time so that instead of increasing their spending power, they will prefer to save money.

The increase in tax rates also plays a role in people's consumption capacity. When this condition occurs, of course, consumers will reduce their spending power with the aim of saving spending.

What is the impact of deflation?

As explained in the beginning, deflation will make the profit earned by a company become little or even losses. Of course, the company itself does not want to constantly be in such conditions that they will take the decision to reduce its workforce. From the reduction of labor, this will make the unemployment rate increase. The higher the unemployment rate, the more difficult it will be for many of them to earn income, resulting in what has been explained before, namely the purchasing power of the community decreases. This condition can certainly worsen economic activity in a country where public consumption is one of the incomes of a country.

In addition, deflation can also lower the minimum wage. Why is it going downhill? This is an effort so that a company can control their finances so that it does not fall at the point where they will suffer losses. When the minimum wage decreases, people's welfare will be reduced because they realize very well that their income will be less as a result of the circumstances that befall them.

How To Solve The Problem of Deflation?


A country can loosen its policies, for example by lowering the tax rate so that people's spending on the state becomes lighter and they can divert other expenditures for commodities according to their needs.

When viewed from monetary policy, the central bank can make policy to cut interest rates which will later make borrowing costs cheaper. This situation will encourage people to be willing to apply for loan fees as a cost for purchasing products based on needs. This can later trigger public demand over time to increase. On the other hand, manufacturers will respond to this situation by increasing their output and production factors, one of which is by recruiting workers. This recruitment can then reduce the high unemployment rate.

© 2021 Farhan Saidi

Related Articles