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Chapter 20: Problem 5

What problems does deflation cause?

Short Answer

Expert verified
Deflation can cause significant issues such as decreased consumer spending due to anticipated lower prices, increased real value of debt making repayments costly, and stagnation of economic growth due to reduced investment by businesses due to low revenue from sales.

Step by step solution

01

Define Deflation

Deflation is a decrease in the general price level of goods and services typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.
02

Problem 1: Decreased Consumer Spending

When people expect that goods and services will be cheaper tomorrow than they are today due to deflation, they might delay their spending. This decrease in consumer spending can lead to a decrease in business revenue, which can then lead to layoffs and a surge in unemployment rates.
03

Problem 2: Debt Increase

The real value of debt increases during deflation, as the value of currency increases. For borrowers, repayments can become more costly, and for lenders, there's an increased risk of defaults on loans.
04

Problem 3: Stagnation of Economic Growth

As a result of reduced consumer spending and costly debt repayments, businesses may reduce investment in operations and expansion. This lack of investment can lead to stagnation in economic growth.

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Most popular questions from this chapter

The unemployment rate declined from 4.5 percent in March 2017 to 4.4 percent in April. The labor force participation rate also declined from March to April, from 63.0 percent to 62.9 percent. If the labor force participation rate had remained unchanged from March to April, would the unemployment rate for April have been lower than, higher than, or equal to 4.4 percent? Briefly explain.

The chapter states that it is impossible to know whether a particular nominal interest rate is "high" or "low." Briefly explain why.

Homemakers are not included in the employment or labor force totals compiled in the BLS household survey. They are included in the working-age population totals. Suppose that homemakers were counted as employed and included in labor force statistics. How would that change affect the unemployment rate, the labor force participation rate, and the employment-population ratio?

Which is a greater problem: anticipated inflation or unanticipated inflation? Briefly explain.

An article in the Economist about Venezuela stated, "The economy is in such an appalling state, and inflation is so high, that Venezuelans greeted a rise of \(60 \%\) in the minimum wage on May 1 st with shrugs of 'so what?" What would be two reasons the people of Venezuela would shrug off a rise in the minimum wage of 60 percent?
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