Macroeconomics commentary on deflation Assignment

Macroeconomics commentary on deflation Assignment Words: 714

This article is related to the problem of the threat of the deflation in Europe. European economists split up to the two different sides. One says that such low inflation can lead to the deflation, which could destroy economy of the European countries. Another group thinks that there is no need to panic, “… Much of the unexpectedly low inflation in the European Union statistics office reported resulted from failing energy prices, not slow growth”, and that nowadays low inflation is not so bad thing “because it creates a buffer against deflation”.

Deflation – sustained decrease in the general price level . Deflation occurs when supply increase or demand decrease. Actually there is a didst notion between two causes Of deflation: decreases in aggregate demand (AD), which causes “bad” kind of deflation and increases in aggregate supply (SARA), which are lead to “good” type of deflation. Decreasing of the AD is caused by Europe suffering from the economic crisis of 2008; it caused disinflation. Actually 0,5% inflation is not far from the deflation. “When price are falling on a broad front, consumers delay major purchases because they expect prices to drop even more.

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Companies suffer clines in sales and cannot invest or create jobs”. This leads to the increase in cyclical unemployment. As we can see there is obvious effect of the spiral, which is destructive for the economy of country. For example, deflation of the Great Depression during the asses that created a deflation spirals. Also deflation will beat firms and government, because total revenue of firms decreases therefore profit and investments and decreases, and therefore taxes decrease. Moreover deflation affects banks, because interest rates decreases so income from deposits decreases too.

Therefore people draw none from their bank accounts. But there is one more argument for the anti-deflation camp. According to their statistics annual increase in prices caused by Easter Bunny effect, took place at March during the last year. And in this year price increases are expected at April. This means that we cannot evaluate level of inflation until May. To control AD changes, government uses demand-side policies: fiscal and monetary. In monetary policy there are three options to use against low inflation: decreasing reserve requirements, discount rate and purchasing open market operations.

First two instruments Anton be used now. It is no space to manipulate with discount rate because it is at its minimum – 0,5%, and so that instrument is useless. So the only one option to use is open market operations. Actually this is the major tool the CB can use to influence interest rates. It is when the CB buys and sells securities, such as short-term government bonds from its member bank. But it can only partially remove consequences of low inflation. And the last instrument to use is operations with corporation bonds. This last instrument is primarily used in USA; it is called Quantitative Easing (CEQ), which is “the

Federal Reserve program of buying bonds from its member banks”3. This method is used on order to lower interest rates. But here is a controversy: US is unitary state with nearly the same laws in different states but Euro Zone there are a lot of countries with very different economic situations and goals. And so it is hard to understand, which companies bonds CB have to buy. So we can conclude that in Europe this low inflation can transform to a deflation in close future, if CB will not solve this problem. But even if CB will take radical decisions and use CEQ such as in USA it will cause long-term effects.

But if CB doesn’t use such radical methods, this whole situation with low inflation can grow up to the same crisis as Great Depression was. But not all stakeholders will be affected by deflation. Price drop will benefit consumers, but only in short-term, because in long-run consumers will face deficit of goods and services because it will be not remunerative for business to sell them for low prices. And the most painful question, which was posed to CB, is what type of policy they are going to use and how far they can go to prevent new economic crisis.

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Macroeconomics commentary on deflation Assignment. (2020, Dec 04). Retrieved January 20, 2021, from