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Negative Inflation

Last modified: Jul 24, 2023

What is happening with the economy these days? We have all been hearing a lot about deflation and inflation, but what does that mean for our wallets and bank accounts? Although it might sound like good news at first, it has some negative consequences. 

In this blog post, we will explore the concept of negative inflation and what it could mean for you. Keep reading to learn more!

Negative Inflation

What Is Negative Inflation?

Negative inflation is a situation where prices are falling instead of rising. This means that the purchasing power of money is increasing because you can buy more with the same amount of cash.

Understanding Deflation 

Negative inflation is a decrease in the prices of goods and services over time. It can happen when the inflation rate falls below 0%. Another term used to describe negative inflation is deflation. 

And what causes deflation? 

The two major causes of negative inflation are a fall in demand and an increase in supply. 

Negative inflation can be a sign of economic trouble since it generally indicates that demand is weak and businesses are struggling. So while negative inflation may seem like a good thing at first glance, it's essential to understand the potential risks involved.

What Is the Difference Between Inflation and Deflation?

Inflation is a sustained increase in the prices of goods and services in an economy over a period of time. When the price rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money — a loss of real value in the medium of exchange and unit of account within the economy. 

The opposite of inflation is deflation. Deflation def can be explained as a sustained decrease in the general price level of goods and services.

Inflation affects economies in various positive and negative ways. Low or moderate inflation may help reduce unemployment during recessions by giving businesses more flexibility in lowering their prices without worrying about significant decreases in their nominal wages, effectively making them more competitive and leading to economic problems. 

Causes of Deflation 

We determined that negative inflation can be bad for the economy, but what causes deflation?

There are many factors that can cause deflation, including a decrease in the money supply, a decline in economic confidence, lower production costs, technological advances, wars, natural disasters, etc. Let’s take a closer look!

Money Supply

A decrease in the money supply can happen when the central bank tightens monetary policy by increasing interest rates. This often leads to higher borrowing costs.

Read more: How Much Money to Keep at Home?

A Decline in Economic Confidence

Economic confidence declines when consumers become less confident about the future and save more instead of spending. This reduces demand and can lead to falling prices.

Lower Production Costs

A decrease in price for key production inputs will lower production costs. Producers will be able to increase production output, which will result in an oversupply in the economy. If demand remains unchanged, producers will need to lower their prices on goods to keep people purchasing them. 

Technological Advances

Technological advances can often lead to an increase in aggregate supply, which will allow producers to lower the costs. This can result in lower prices for goods and services and can cause deflation.

Effects of Deflation

Deflation can have a number of effects on the economy, both good and bad.

Increase in Unemployment

Businesses are less likely to invest and expand when prices are falling, so they cut back on their workforce. This can lead to a downward spiral as people spend less money, leading to even lower prices.

Increase in the Real Value of Debt

Another effect of deflation is an increase in the real value of debt. When prices fall, the amount of money you owe grows in real terms. This can be a problem for people with large debts, such as mortgages, as they may find it challenging to keep up with their repayments.

Deflation Spiral

Deflation can also lead to a deflationary cycle where people expect prices to fall further, saving rather than spending their money. This can lead to even lower demand and prices, creating a vicious circle.

Overall, deflation can have both positive and negative effects on the economy. It’s essential to be aware of these potential effects when making economic decisions.

Debt, Speculation, and Debt Deflation

Speculation is the act of conducting financial transactions with substantial risk and holding out hope for a significant gain or another great reward. Speculators take more chances than they would if their only goal was safety because there's always the potential that something will go wrong — which means you can lose quite heavily without ever having done anything wrong.

The debt-deflation theory suggests that when prices fall and currency increases, people are more likely to default on their debts. This leads us into an economic downturn where our society's wealth is decreasing. At the same time, everyone struggles with higher interest rates or medical bills from unpaid expenses because they can no longer afford them. 

This theory was first introduced by 20th-century economist Irving Fisher. He believed this process would lead to economic stability because it makes people worry about paying off their loans or obligations and reducing demand for goods due to consumers' frantic efforts to save money.

Bottom Line 

So what does all of this mean for the average person? 

In short, it means that prices are slowly starting to creep up, but most people likely won’t notice because their wages aren’t keeping pace. 

That said, you can do a few things to protect yourself from negative inflation and keep your spending power in check:

  1. Try to save as much money as possible so you have a cushion against rising prices.
  2. Secondly, invest in assets like stocks or property that may appreciate over time. 
  3. Stay informed about changes in the economy and how they might impact your finances.

Read more: 27+ Crucial Financial Statistics (2022 Update)  


Is Deflation Good or Bad?

It all depends on defining "good" or "bad." Deflation can be seen as bad because it increases the value of money, making it more difficult for debtors to pay their debt. It also can lead to decreased demand for goods and services and fewer jobs.  On the other hand, deflation can be good for consumers since it gives them more purchasing power. 

Has America Ever Had Negative Inflation?

There were a few periods of negative inflation in America's history. The most notable instance occurred during the Great Depression. Deflation set in at the beginning of the depression and lasted for several years.

Which Is Worse: Inflation or Deflation?

There is no definitive answer to this question as it depends on the specific situation and context. In general, however, deflation is often seen as being worse than inflation because interest rates can only be lowered to zero.

How Do You Make Money During Deflation?

There are a few ways to make money during negative inflation.  One is to invest in assets, such as dividend stocks, consumer-staple stocks, and investment-grade bonds. Another is to provide goods and services in high demand and offer a good deal. Finally, you can reduce expenses and save money.

Policy Advice is a website devoted to helping everyday people make, save, and grow money. While our team is comprised of personal finance pros with various areas of expertise, nothing can replace professional financial, tax, or legal advice.

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