Deflation

What is Deflation?

Deflation is a decrease in the price level of goods and services. This decrease in the price level leads to an increase in the real value of money. In other words, each dollar you have will buy more goods and services than it did before. Deflation can be caused by a decrease in money supply, a decrease in government spending, or a decrease in private sector spending.

The Causes of Deflation

Deflation is most often caused by a decrease in the money supply. When the money supply decreases, there is less money available to buy goods and services. This decrease in demand leads to a decrease in prices. Deflation can also be caused by a decrease in government spending or a decrease in private sector spending.

The Effects of Deflation

Deflation has both positive and negative effects. The positive effects of deflation include an increase in the real value of money and a decrease in interest rates. This makes it cheaper to borrow money and encourages savings. The negative effects of deflation include a decrease in aggregate demand and an increase in unemployment. Deflation can also lead to a debt spiral, where the decrease in prices makes it harder to repay debts.

How to Combat Deflation

There are two main ways to combat deflation: fiscal policy and monetary policy. Fiscal policy involves the government increasing spending or decreasing taxes in order to increase aggregate demand. Monetary policy involves the central bank increasing the money supply or decreasing interest rates in order to increase aggregate demand.

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