What is Deflation and why Does it Matter?

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Many aspects of traditional finance and economy remain unclear to a lot of people. That is very strange in this day and age, as everyone should be able to highlight the issues with ease. Deflation is a term nearly everyone has heard of by now, but what does it even mean? 

Deflation can be Beneficial

Contrary to inflation, deflation is often considered to be a very prominent and positive development. It indicates a time during which prices for most goods and services are declining. For consumers, paying less money for the same amount of goods is always a good thing, as it signals a significant increase in overall purchasing power.

One has to wonder what could trigger a state of deflation. The number one cause is a contraction in the supply of money and credit. Given how central banks operate  these days, a contraction in the money supply is rather unlikely. The use of helicopter money only serves to increase the supply, which is far from ideal. 

Another potential cause of deflation is increased productivity, or technological improvements. This latter aspect seems more likely in the modern era, as technology keeps evolving at a very rapid pace. A lot of these developments will eventually yield more efficiency when producing goods. Whether that will come at the cost of human jobs, remains a topic of debate. 

If push comes to shove, deflation can also be triggered due to a decrease in aggregate demand for goods and services. This is primarily noticeable on an export level. However, it is possible that certain goods and services are no longer in demand on the domestic market either. It is a rare situation, but it does happen every now and then. 

There are Downsides too

Whether one wants to admit it or not, every positive has a negative tied to it. Deflation sounds beneficial to consumers on paper, but that isn’t necessarily the case. If prices are falling, so do labor wages. Earning less money is never a viable option for most people, even if that means prices of goods were driven down in the process. 

Moreover, those who have a debt to pay off – mortgages, for example – would find themselves in an interesting situation. The money they use to pay their debts could be worth more than the money they borrowed, as these rates will not be adjusted. 

Changing the Investment Game

Deflation can also have severe repercussions for the global investment market. During a time of deflation, companies with little debt or massive cash reserves become all the more attractive. 

Under normal circumstances, companies are of great interest if they are spending  a lot of money to improve their market position. Very few companies realize that this particular approach is not sustainable in the long run. 

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