Deflation

deflationarydeflationary spiralmoney supply contracteddeflatednegativedeflatedeflation policydeflationistdisflationfall in prices
In economics, deflation is a decrease in the general price level of goods and services.wikipedia
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Inflation

inflation rateprice inflationfood inflation
Deflation occurs when the inflation rate falls below 0% (a negative inflation rate).
The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services.

Disinflation

decreaseddisinflationary scenarioinflation decline
Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.
If the inflation rate is not very high to start with, disinflation can lead to deflation – decreases in the general price level of goods and services.

Liquidity trap

liquidity-trapslack in the economy
This can produce a liquidity trap or it may lead to shortages that entice investments yielding more jobs and commodity production.
A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

Great Depression

DepressionThe Great DepressionDepression era
It was proposed as a theory by Irving Fisher (1933) to explain the deflation of the Great Depression.
By mid-1930, interest rates had dropped to low levels, but expected deflation and the continuing reluctance of people to borrow meant that consumer spending and investment were depressed.

Long Depression

Depression of 1873–79depressioneconomic depression
This deflation was at times caused by technological progress that created significant economic growth, but at other times it was triggered by financial crises — notably the Panic of 1837 which caused deflation through 1844, and the Panic of 1873 which triggered the Long Depression that lasted until 1879.
Though a period of general deflation and a general contraction, it did not have the severe economic retrogression of the Great Depression.

Panic of 1837

financial panic of 1837financial crisis of 18371837
This deflation was at times caused by technological progress that created significant economic growth, but at other times it was triggered by financial crises — notably the Panic of 1837 which caused deflation through 1844, and the Panic of 1873 which triggered the Long Depression that lasted until 1879.
The years 1837 to 1844 were, generally speaking, years of deflation in wages and prices.

Real versus nominal value (economics)

inflation-adjustednominal valuenominal
Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, especially if the deflation is unexpected.

Aggregate demand

disaggregationKeynesian formulaaggregate
When purchases are delayed, productive capacity is idled and investment falls, leading to further reductions in aggregate demand.
Second, when they do suffer price cuts (as in Japan), it can lead to disastrous deflation.

Overproduction

oversupplyglutover-produced
The fall in demand causes a fall in prices as a supply glut develops.
The general reduction in the level of prices (deflation) caused by the law of supply and demand also forces businesses to reduce production as profits decline.

Friedrich Hayek

Friedrich von HayekF. A. HayekF.A. Hayek
Nobel laureate Friedrich Hayek, a libertarian Austrian Economist, stated about the Great Depression deflation:
In 1932, Hayek suggested that private investment in the public markets was a better road to wealth and economic co-ordination in Britain than government spending programs as argued in an exchange of letters with John Maynard Keynes, co-signed with Lionel Robbins and others in The Times. The nearly decade long deflationary depression in Britain dating from Winston Churchill's decision in 1925 to return Britain to the gold standard at the old pre-war and pre-inflationary par was the public policy backdrop for Hayek's dissenting engagement with Keynes over British monetary and fiscal policy.

Quantitative easing

credit easingQEQE3
Thus the central bank must directly set a target for the quantity of money (called "quantitative easing") and may use extraordinary methods to increase the supply of money, e.g. purchasing financial assets of a type not usually used by the central bank as reserves (such as mortgage-backed securities). The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing', but did not create a sustained increase in broad money and deflation persisted.
An unconventional form of monetary policy, it is usually used when inflation is very low or negative, and standard expansionary monetary policy has become ineffective.

Ben Bernanke

Ben S. BernankeBernankeBen S. Bernanke, Chairman and a member of the Board of Governors of the Federal Reserve System
Studies of the Great Depression by Ben Bernanke have indicated that, in response to decreased demand, the Federal Reserve of the time decreased the money supply, hence contributing to deflation.
In 2002, following coverage of concerns about deflation in the business news, Bernanke gave a speech about the topic.

Recession

economic recessioneconomic downturndepression
Deflation usually happens when supply is high (when excess production occurs), when demand is low (when consumption decreases), or when the money supply decreases (sometimes in response to a contraction created from careless investment or a credit crunch) or because of a net capital outflow from the economy.

Irving Fisher

FisherIrving FischerFisher, Irving
It was proposed as a theory by Irving Fisher (1933) to explain the deflation of the Great Depression. Another related idea is Irving Fisher's theory that excess debt can cause a continuing deflation.
Once the Great Depression was in full force, he did warn that the ongoing drastic deflation was the cause of the disastrous cascading insolvencies then plaguing the American economy because deflation increased the real value of debts fixed in dollar terms.

Debt deflation

debt-deflationdeflationary policiesexcess debt can cause a continuing deflation
Another related idea is Irving Fisher's theory that excess debt can cause a continuing deflation. Some economists believe the United States may have experienced deflation as part of the financial crisis of 2007–10; compare the theory of debt deflation.

Fiat money

fiat currencyfiatfiat currencies
Most nations abandoned the gold standard in the 1930s so that there is less reason to expect deflation, aside from the collapse of speculative asset classes, under a fiat monetary system with low productivity growth.
Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy.

Economic history of Japan

second largest economyJapanese-style deflationary outcomeas in Japan
To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans (as in Japan, and most recently America and Spain).
As Japanese products became less competitive overseas, some people argue that the low consumption rate began to bear on the economy, causing a deflationary spiral.

Keynesian economics

KeynesianKeynesianismKeynesian theory
Keynesian economists argued that the economic system was not self-correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending.
According to the theory, government spending can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation.

Velocity of money

velocitymoney velocityIncome velocity of money
From a monetarist perspective, deflation is caused primarily by a reduction in the velocity of money and/or the amount of money supply per person.
Those favoring a quantity theory of money have tended to believe that, in the absence of inflationary or deflationary expectations, velocity will be technologically determined and stable, and that such expectations will not generally arise without a signal that overall prices have changed or will change.

Bank of Japan

BOJCentral BankJapan
The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing', but did not create a sustained increase in broad money and deflation persisted.
Following the election of Prime Minister Shinzō Abe in December 2012, the Bank of Japan, with Abe's urging, took proactive steps to curb deflation in Japan.

Federal Reserve

Federal Reserve SystemUS Federal ReserveU.S. Federal Reserve
These deflationary periods preceded the establishment of the U.S. Federal Reserve System and its active management of monetary matters.
Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy.

Causes of the Great Depression

Bank Moratoriumcause of the Great Depressioncauses
This was followed by a deflation in asset and commodity prices, dramatic drops in demand and credit, and disruption of trade, ultimately resulting in widespread unemployment (over 13 million people were unemployed by 1932) and impoverishment.

Macroeconomics

macroeconomicmacroeconomistmacroeconomic policy
A deflationary spiral is the modern macroeconomic version of the general glut controversy of the 19th century.
When prices decrease, there is deflation.

Financial crisis of 2007–08

financial crisis of 2007–2008global financial crisis2008 financial crisis
Some economists believe the United States may have experienced deflation as part of the financial crisis of 2007–10; compare the theory of debt deflation.
This was done to soften the effects of the collapse of the dot-com bubble and the September 2001 terrorist attacks, as well as to combat a perceived risk of deflation.

The Great Deflation

The third was after the Civil War, sometimes called The Great Deflation.
By contrast to the mild deflation of the so-called Great Deflation, the deflation of the 1930s Great Depression was so severe that deflation today is associated with depressions, although economic data are not quite as clear on the matter.