Why deflation is bad

If prices are falling and things are getting cheaper, that should be a good thing, right?! Well, not really…🙈 ⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀
Falling prices, a.k.a. deflation, is akin to an economists’ worst nightmare (well, almost…). For one, it’s quite possible that the likelihood of prices falling further👀 will cause people to delay making purchases… which leads to more price declines and more people holding off making purchases📉🤕. ⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀
The argument is probably too simple (people will keep buying food, for example) – but the point is that falling prices deter people from making purchases now, which hurts overall economic growth. ⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀
Perhaps more importantly, some inflation is necessary 😐in an economy that relies to a large degree on people, companies and governments borrowing money (and virtually major economies rely on that). Inflation naturally erodes the value of debt🤔 (because that debt becomes progressively worth less with time and thus becomes easier to repay👌).
In a highly indebted society, like the US, UK, Europe and Japan – a reasonable rate of inflation helps reduce that debt. That’s good because too much debt leads to decreased spending (if cash is being used to pay interest payments or pay back debt, there is less to be spent on economically productive things like hiring workers👩‍⚕️). And spending – on things like building factories, hiring workers or, even, just buying a toaster – is what drives economic growth. ⠀⠀⠀⠀

Another corollary of that point is to think of the cost of holding onto cash. If inflation is high, the value of that cash gets eroded more quickly than if inflation is low – and so there is an incentive to “put that cash to work” by, for example, investing in building a new factory so that a better return is generated (and the value of that cash, net of inflation, grows).

When inflation is low (or there is deflation), the motivation to put cash to work is diminished because the cost of holding onto that cash is so low. And so factories don’t get built and more workers aren’t hired – which is, of course, bad for the economy.

Subscribe to Huuti