Konstantin Boykachev

CEO Proforexea LLC

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Konstantin Boykachev

CEO Proforexea LLC

Honest Coder

Professional Trader

Blog Post

Why the US, Japan and Europe are afraid of deflation

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While the CIS countries are trying with all their might to contain inflationary processes (relatively successfully), in developed countries the situation is completely opposite. Faced with deflation, Japan started thinking about “Helicopter Money”, although other sources say the idea was launched in 2016. In 2020, an unprecedented amount of money was poured directly into households in the United States. In Europe, they are trying to fight deflation in the economy with the help of quantitative easing policy and negative rates. At the very least, there is an effect. So why, while some are struggling with the problem of the depreciation of the national currency for others, its strengthening is a problem?

Deflation in the economy: essence, causes, consequences

Both inflation and deflation in the economy have practically the same consequences, but their essence is radically opposite. Inflation is the depreciation of the national currency against other currencies, followed by a rise in prices and a decrease in purchasing power. Deflation is the opposite phenomenon, characterized by falling prices and an increase in the purchasing power of money.

Logically, lower prices should have led to an increase in demand. But this rule only works in developing countries where the population still has a desire to buy something.

Deflation reasons in the economy:

  • Growth in demand for the national currency. It appears when the population gives preference to increasing savings, “washing” money out of the economy. Instead of turning around bringing added value, money is dead weight. With the policy of saving, demand falls, and the result is that prices fall.
  • Production growth above the level of demand (overproduction crisis). The manufacturer is forced to cut prices at a loss.
  • State regulation by changing discount rates, cutting credit programs.

Lower prices make it easier for manufacturers to cut production or stop it altogether than to sell goods for a penny. Declining profits for manufacturers lead to lower investment in new technologies. The economy stops growing, stops following the path of technical progress, and unemployment begins to rise. And then everything goes in a spiral.

To combat deflation in the economy, any methods of stimulating production and stimulating the population to spend money are used. For example, reducing the tax burden and concessional lending. Negative interest rates mean that depositors have to pay extra for keeping money. Legislation may require, for example, changing vehicles every 10 years (incentivizing the auto industry). Scientific and technical developments will push to change household appliances, etc.

Another problem with deflation is that it is difficult to predict the consequences of methods of dealing with it. If raising interest rates, stimulating production and exports, attracting investment, and controlling the money supply – have a restraining effect on inflation, then methods of combating deflation can lead to even greater problems. After all, there is no point in reducing rates below a negative value. And filling the economy with money can:

  • Lead to the opposite problem – inflation. Even worse, if she turns out to be out of control.
  • Lead to a postponed problem without solving the main problem. The population will simply “hide money under the pillow.” And at what point this money will enter the economy, whether it will benefit the economy is a question.

Inflation and deflation are the two scales, and the central bank is the oversight body that tries to keep both scales in balance. Sometimes he succeeds, sometimes he does not. But any movement of the weights in one direction or the other is an economic problem.

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