In economics, deflation is a general, significant and sustained decline in the price level for goods and services. Deflation occurs when aggregate demand is lower than aggregate supply ( sales crisis ). Deflation can coexist with depression . Historically, however, there have also been periods of deflation that have been accompanied by adequate economic growth.
Price reductions have a positive impact on welfare if they are based on increased efficiency. In contrast, the price cuts in deflation are mostly due to a lack of demand. This means that companies no longer invest because investments no longer promise a profit and consumers push back their consumer spending as much as possible because the products are becoming cheaper and cheaper. Deflation then leads to a severe economic crisis and high unemployment, such as B. in the Great Depression .
Goods and services are getting cheaper all the time. As a result, companies' profit expectations fall, they invest less and instead try to cut costs, e.g. B. by reducing the production of goods ( short-time work , location closings , etc.), by layoffs and by lowering wages. The unemployment rising, income is down. Less can be consumed, the demand for consumer goods shrinks and the state's tax revenues decline. The overall economic output is decreasing increasingly. If countermeasures are not taken, an economic crisis arises .
While prices, profits, and wages fall in deflation, the face value of loans and other debt instruments remains unchanged. This puts debtors at a disadvantage because their credit- financed material goods lose value in monetary units, but they still have to pay the same initially fixed monetary value. In contrast, owners of financial assets benefit from deflation because their capital - adjusted for interest - now has a higher value than at the beginning of the period. As a result, indebted companies are increasingly becoming insolvent , with negative effects on their employees and creditors . The further consequence can be a debt deflation , i.e. a financial crisis and a deflation that is intensifying due to the austerity measures of the economic players, with the consequence of the deepening of the economic crisis.
The purchasing power of consumers increases if wages do not fall more than prices. If wages remain stable even though the companies can no longer finance wages in the high amount (wage rigidity), this leads to company insolvencies.
Monetary Policy Response
"Classic deflations" in the form of a massive drop in prices across a wide range of goods and services had, e. For example, in the Great Depression around 1930, there was a strong tendency towards a certain permanence. Once a country suffered from a deflationary phase, the risk of a self-sustaining or even self-reinforcing tendency was very high: falling prices and incomes led to a noticeable reluctance to buy on the part of consumers, as they expected further falling prices and incomes. The falling demand in turn resulted in lower utilization of production capacities or even bankruptcies and thus further falling prices and incomes. Due to the negative impact on creditors, e.g. Banks, for example, restrict their lending, which reduces the money supply and makes economic growth difficult. This cycle is commonly referred to as the deflationary spiral.
Since the advent of Keynesian and monetarist theory, deflation has been considered preventable. So z. B. Ben Bernanke assumes that deflation can be ended quickly through monetary and fiscal policy measures, if necessary also through quantitative easing . In the context of the financial crisis from 2007 onwards , a “risk of deflation” was seen. In Japan , prices have been falling since the 1990s.
Consumer and investment reluctance
When an economy is in a downturn in a business cycle , people react cautiously. They expect their income situation to deteriorate, they fear for their jobs , and therefore spend less money in the expectation of a lower income in the future and the resulting attitude towards securing a livelihood . An increased increase in personal financial reserves only sets in if the inflow of money for the person does not decrease as much as the outflow of money.
The companies are holding back. Only the bare essentials are bought and little is invested (so-called reluctance to invest). This drop in demand means that companies achieve lower sales or profits and rationalize in the early stages (often through mass layoffs) or ultimately, in the last instance, become insolvent . Overall, the total demand for goods is now falling while the supply of goods remains roughly the same ( demand gap ).
In principle, lower needs are the cause of consumer reluctance. Whether these lower needs result from self-control or from a lack of money is a different matter. A greater propensity to save can also be a reason, caused by worsened expectations for the future. This phenomenon can currently be observed in Japan (as of 2011).
Asset deflation, credit deflation
Especially through the bursting of speculative bubbles such as B. Real estate bubbles cause wealth deflation, especially when the assets have been financed by credit . The falling asset prices then lead to over-indebtedness of households, which leads to loan defaults and also to the banks. Since fewer new loans are granted than expire and default, the money supply is falling . Consumers can also hardly finance their consumer spending with loans, so that demand in the economy is falling. So wealth deflation can set off general deflation.
The economist Heiner Flassbeck speaks of "debt deflation", which has its causes in the speculation of banks and funds on permanently rising prices of assets and the market value of certain currencies. If these bets collapse, investments have to be feverishly sold, the prices of which fall like a collapse due to the simultaneous high supply. Such a downward spiral exceeds the so-called "self-healing powers" of the market.
Because of the positive feedback of the development of wages and prices ( wage-price spiral ), deflation or wage deflation leads to a cumulative self-reinforcing process in an economy in which goods and factor prices fall simultaneously. If long-term deflation expectations emerge, it is extremely difficult for the central bank to break them with an expansionary monetary policy . This phenomenon is known as the liquidity trap : Due to solidified deflationary expectations in the economy, even nominal interest rates of zero percent offer no incentives for commercial banks to lend investors or consumers.
Due to the general uncertainty about future economic developments as a result of deflation, the creditors consider the credit risks of the creditors vis-à-vis potential debtors to be higher than the interest income that can be achieved by lending to the creditors. Credit rationing by credit institutions then prevents the potentially available liquidity from being converted into effective demand from investors and consumers through the central bank's zero interest rate policy , which would be entirely possible through increasing lending by commercial banks. Only when the economy regains confidence in the near end of deflation will the liquidity trap in which monetary policy is stuck will be resolved and the normal causal relationship will be restored.
Increasing competition through domestic or foreign trade liberalization usually has the effect of reducing prices. Deregulation measures such as the abolition of (possibly state) monopolies or price controls and increased international free trade can therefore have deflationary effects, if they are made across the board and affect a number of industries.
Reduction in government spending
Another possible source of deflation is the government sector . If a government drastically cuts government spending, for example in order to reduce the budget deficit or to achieve a budget surplus, the government demand on the markets will be lower, and a demand gap will be reached again if the supply remains the same .
External economic influences can also trigger a deflation-generating excess supply:
Second, through the appreciation of their own currency , which makes exports more expensive for foreign customers. If, for example, the euro appreciates against the US dollar , i. H. The euro exchange rate rises in relation to the USD, the dollar prices for German export goods in the USA rise and the demand for these goods falls. At the same time, the appreciation of the domestic currency makes imported products cheaper and also puts pressure on domestic production, which may also have to reduce its prices. Both are reflected in the domestic price level.
When a country pegs its currency (for example through a currency board ) to that of another country, this results in higher productivity growth , more favorable development in unit labor costs, or the like. it must either become more productive to the same extent or lower its factor prices (e.g. wages) in order to maintain its competitiveness. The latter leads in the direction of deflation. Currency unions have an effect analogous to that of fixed exchange rate systems .
According to monetarist ideas, inflation and deflation are always and everywhere a monetary phenomenon ( Milton Friedman ). The underlying idea is that a restrictive monetary policy (increase in the minimum reserve , increase in the interest rate ) leads to lower prices via the quantity equation . But even from a non-monetarist point of view, a restrictive monetary policy leads to deflation, as it dampens overall economic demand (for example due to higher central bank interest rates) .
Quantity theory approach (monetarism)
In deflation, the nominal profit, the nominal value of businesses, and the nominal value of labor decrease while the value of credit remains stable. The real debt burden increases with a general fall in prices. This has tremendous effects in a modern economy because the amount of book money is many times higher than the amount of cash . Book money is an amount of money created by the lending of banks ( deposit money creation ). The fact that a prolonged deflation phase causes depression was first shown by Irving Fisher in The Debt-Deflation Theory of Great Depressions (1933). He described a chain of circumstances that lead to debt deflation :
- Debtors try to become solvent in the short term with distress sales (sales at very low prices).
- The repayment of debts leads to a reduction in the deposit money creation of the banks and thus to a reduction in the money supply.
- By reducing the money supply, the price level falls.
- As a result of the falling price level, the company values fall. The creditworthiness of companies is reduced, which makes it difficult to extend or reschedule loans.
- Corporate profits are falling.
- Companies are cutting production and laying off workers.
- There is a general loss of confidence in the economic situation.
- Instead of investing, money is hoarded.
- Although nominal interest rates are falling, the general decline in prices increases the real weight of the interest burden.
The result of debt deflation is apparently paradoxical: the more debts are repaid, the more the money supply falls (if the government and central bank do not intervene in reflationary fashion, as at the beginning of the global economic crisis ), the more the price level falls, the more oppressive the real weight of the remaining debt burden becomes .
Liquidity hypothesis (Keynesianism)
While neoclassical theory had always maintained that changes in prices had no effect on the real economy, John Maynard Keynes warned as early as 1923 of the consequences of deflation associated with a return to the international gold standard . The fall in prices would mean losses for investments and bring credit-financed businesses to a standstill. Entrepreneurs would best get out of business altogether during a severe deflation and everyone should put off planned spending as long as possible. A wise man would monetize his investments, keep himself away from all risks and activities and wait in rural seclusion for the constant increase in the value of his money.
On the basis of the general equilibrium theory, debt deflation leads to a redistribution of purchasing power from debtors to creditors, but the market remains in equilibrium . In this model, it is not the debt deflation itself, but rather the expectations that it creates that has fatal consequences. Normally, low interest rates would send an investment signal (but do not do so if the entrepreneurs expect demand to continue falling and real interest rates to rise - see also investment trap ). Experience shows that during a deflation, consumers and entrepreneurs assume that wages and prices will fall even further in the future due to falling wages and prices. Since people expect that the real debt burden will increase over time due to falling wages and profits, and that revenues will decrease, they forego consumption or investment ( savings paradox ). Since loans are being repaid and new loans are taken out only very cautiously, net borrowing across the whole sector is reduced, the money supply decreases, which means that the deflationary spiral continues to turn downwards.
Free economy theory
The free economy theory - which is rejected by the vast majority of economists - sees what it believes is the falling velocity of the money circulation as the main cause of deflation. According to free economics theory, this “hoarding of money” arises from the fact that an investment whose return is lower than the liquidity premium is no longer lucrative and the supply of money on the capital market therefore declines.
As the quantity theory of money suggests, deflation can arise not only from a shortage in the supply of money, but also from an expansion in the supply of goods. If this is the case, deflation can definitely have a positive effect on the prosperity of the population because it has more purchasing power with the same nominal wages. During the second industrial revolution from 1873 to 1896, the supply of goods expanded due to new technologies and the worldwide expansion of railway networks, while the accession of some European countries (Germany, Belgium, the Netherlands, Scandinavia and later France) to the gold standard reduced the amount of money. That period saw an average deflation of 2% a year with an annual growth of 3%. In the “golden” 1920s, the supply of goods also grew, primarily due to the proliferation of automobiles, refrigerators and radios in US households. Deflation during this period was 1–2% per year.
A similar phenomenon, known as digital deflation, can currently be observed in the IT sector: the price of products in this sector is falling steadily due to constant technological improvements - a modification of Moore's Law predicts that the price of an IT product will be halved for about all 18 months. Since the price cuts only affect a certain industry and not the overall economy, the term deflation is actually wrong.
Until the 1930s, most economists believed that deflation was overcome by the free play of market forces. The falling price level will lead to rising demand again even without government intervention ( liquidation thesis ). The world economic crisis refuted this thesis. In the United States, deflation was tackled under the New Deal through changes in monetary policy, particularly a move away from the gold standard . The German government under Hitler and Hjalmar Schacht as Reichsbank director managed to successfully fight deflation with the Mefo bills of exchange . To do this, they increased the money supply.
It was reflationary policies developed as a potential countermeasure against deflation.
All economic policy measures of the central bank are referred to as monetary policy . Since they play an important role in fighting inflation, they are also important in fighting deflation. So is z. For example, the ECB is obliged to aim for price level stability (and thus neither de- nor inflation). She sees the price target she has set herself with a growth in the harmonized consumer price index of just under two percent .
Central banks generally cut interest rates to combat deflation. Often, however, this leads to a state of no longer increasing demand for money , which is referred to in Keynesian as a liquidity trap , or to interest rates close to zero. This means that an expansionary monetary policy can no longer be achieved through interest rates. Quantitative easing then remains as a monetary policy countermeasure . A country's central bank can use the open market policy to buy up forms of investment that are currently on the market (for example credit claims from commercial banks) in order to be able to further expand the money supply despite zero interest rates.
Demand-oriented economic policy
A pro-cyclical tax policy or an austerity course in response to an economic crisis can lead to a deflation trap, from which an economy can only be led out through a demand-oriented economic policy if other positive influences fail.
In the Great Depression of 1929, government investment programs were often adopted. A theoretical basis for such a policy was created in particular by John Maynard Keynes ( 1936 ). The state is increasing its demand, for example through employment and infrastructure programs - also through loan financing ( deficit spending ) - and lowering taxes in order to give the economy an initial spark.
Since then there has been deflation, particularly in Japan since the early 1990s .
In 2008, Keynesian economists like Heiner Flassbeck expected Germany to slide into deflation as a result of the global financial crisis due to the lack of domestic demand. At the beginning of 2010, Paul Krugman sees Greece trapped in a deflationary spiral due to national debt and rising credit prices, which it cannot counteract without monetary policy room to maneuver. In view of the Greek crisis, EU currency commissioner Olli Rehn has not only called for more effective monitoring of the budgetary policy of the euro countries, but also called on the EU countries with balance of payments surpluses to strengthen domestic demand.
Former IMF boss Dominique Strauss-Kahn sees no alternative to deflation for Greece. According to Desmond Lachman (previously IMF, then AEI ) deflation and depression are the result if Greece does exactly what the IMF and the European Union expect of it.
In addition, other proposed solutions are made that have hardly been taken into account by politics and science. Free economics, for example, calls for the introduction of a money circulation fee as the third monetary policy instrument of the central bank (in addition to the money supply and the interest rate). Furthermore, deflation can also be fought through private initiatives such as exchange rings and / or by issuing a private complementary currency .
Deflations in History
International economic stunted growth in the last quarter of the 19th century
After a prolonged phase of global economic growth since 1850, the economy turned around in 1873 with a rapid collapse in numerous financial markets. The bear market ushered in a sharp turning point that lasted until 1879. An upward trend persisted in the early 1880s, before a violent second crisis that lasted until 1886 set in again. Another sequence of upswings and again slight downswings after the collapse of Barings Bank in 1890 happened up to 1896. Economic theorists of the 1920s postulated a coherent world economic crisis for the period from 1873 to 1896. They referred to this as the Great Depression or Long Depression and understood them as part of a long wave (economic upswing and downswing) from 1850 to 1896. The term founder crisis is also used for the situation in the German Empire and Austria-Hungary . In view of the economic indicators (overall economic growth only decreased slightly, but prices fell by an average of a third), there is more evidence of a price crisis than a production crisis, which is why the alternative epoch designation "Great Deflation" was proposed.
Global deflation during the Great Depression of the 1930s (also known as the " Great Depression " in the USA )
The last major worldwide effective deflation existed in the Great Depression of the early 1930s. This was due to overproduction after the First World War , Black Thursday on the US stock exchanges and the failed policy of the US Federal Reserve, which cut the money supply by 30%. Its own problems prompted the US to reclaim its large loans from Germany , with most of the debt being paid in gold. Since only 40% of the money in circulation in the German Reich had to be covered by gold and foreign exchange , the outflow of gold had a 2.5-fold leverage effect on the amount of money, which consequently sank drastically. As a result, the money in circulation decreased just as quickly, which further intensified the effect. Salaries fell, prices collapsed and unemployment rose to more than six million, representing 20% of the workforce. The then government and employers fueled the crisis even further as they exacerbated deflation through austerity measures and wage cuts (see Deflation Policy ).
In 1932 in the municipality of Wörgl in Austria, deflation was successfully fought with the free money experiment , in which the municipality issued so-called labor vouchers with a monthly security fee of 1% of the nominal value based on the free economics theory of Silvio Gesell . However, the attempt was stopped by the Austrian National Bank after one year because of the violation of the monopoly on money.
Recession in Japan in the 1990s (also known as the "Lost Decade")
From around 1993, Japan suffered from falling prices combined with a severe recession and an increase in unemployment. The financial markets are generally seen as the trigger for the Japanese crisis. The Japanese Nikkei 225 share index rose from 13,000 to over 38,000 points between 1985 and 1989 - the price of an average Japanese share almost tripled in just four years. Similar to share prices, other asset prices developed - e.g. B. for real estate and land. Most economists interpreted this as a speculative bubble that first expanded and then burst.
As a result, the Nikkei index fell from 1990 to 1992 to 16,000 points. Obviously, the huge increase in wealth in the 1980s led to a boom in the demand for Japanese goods and services, which, however, was followed by a no less severe recession after the bubble burst; the sharp losses in asset prices (such as stocks or real estate) prompted Japanese consumers to save significantly more. The resulting reluctance to consume led to underutilization of production capacities and the deflationary spiral described above.
The Japanese state responded with an expansive monetary and fiscal policy. However, in 1997 the IMF and OECD recommended counteracting the increased deficits due to deficit spending by means of restrictive fiscal policy - which would not initiate an economic downturn. A saving paradox arose . Japan fell into deflation. Although central bank interest rates in Japan were close to or at zero for years and the Japanese central bank repeatedly implemented quantitative easing , the private sector could no longer be encouraged to significant additional expenditure (deleveraging) ( balance sheet recession ). Today Japan is by far the most heavily (publicly) indebted industrialized country in the world. A partial end to the crisis was only achieved in 2003 and 2004 through a consequent restructuring policy combined with the central bank buying up bad loans .
Argentina crisis 1998–2002
Argentina suffered from hyperinflation in the 1990s . To stop this, a currency board , through which the country was tied to the US dollar , was set up. Initially, inflation could be reduced significantly, but the state did not manage to get its debt under control, above all not enough taxes could be collected. As a result of the Asian crisis that began in 1998, investors also reassessed Argentina and the Argentine peso as an investment opportunity and lost confidence because of the country's over-indebtedness. The foreign capital withdrawn as a result exacerbated the crisis and forced the Argentine currency board to continuously increase domestic interest rates in order to adjust the money supply to the dwindling foreign exchange reserves. However, the high interest rate policy brought consumption and investment to a collapse and led to a sharp drop in prices ( Argentina crisis ). In early 2002 Argentina gave up its exchange rate peg.
EU countries from 2013/14
In the course of 2013, the monthly consumer price development (year-on-year comparison ) in the EU countries Bulgaria , Greece and Cyprus fell below the zero line. In 2014 this also happened in Spain and Slovakia .
The inflation rates for 2014 and 2015 as a whole were also negative in the countries mentioned, and in Greece they were also negative for 2013 (see table).
Table: Annual rate of change in the harmonized index of consumer prices (HICP) . Negative values are highlighted in color.
Source: Eurostat , accessed 4 February 2018.
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