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Deflation (Consequences (Lower profit margins (Revenue likely to fall,…
Deflation
Consequences
The real cost of borrowing increases
If the interest rate is 4% and the price level falls by 2% (i.e. -2%) then the real interest rate is 6%
Firms and consumers are more likely to save
Central bank will need to reduce the interest rate to incentivise borrowing and discourage saving
Lower profit margins
Revenue likely to fall
Firm cuts staff to reduce costs to seek greater profitability
Debts increase
Increased real debt weakens consumer confidence
Lower consumer confidence
As wealth decreases,...
Holding back on spending
Income distribution
Debtors (who owe money) pay back the creditors (the lenders)
Creditors benefit from the increased real interest rate.
Policies to avoid deflation
Monetary Policies
Lower interest rates
Quantitative Easing
Fiscal Stimulus
Increased government spending, e.g. capital projects
A rise in government spending
Higher taxes on savings to encourage consumption
Attempts to lower exchange rates
Abenomics
Reflationary
Fiscal stimulus
Big rise in capital spending
Structural reforms
To increase productivity
To increase competition
Easing monetary policy
Higher inflation target (2%)
Attempt to devalue Yen
Shinzō Abe, Japanese Prime Minister Economic