Deflation is an economic term that refers to a general decline in the prices of goods and services over a period of time. It is the opposite of inflation, which is the rise in prices.

Causes of Deflation:

Decrease in consumer demand – When people spend less, businesses lower prices to attract buyers. Deflation causes people to hoard money and put off spending it. When the general level of prices is falling, people will think about buying goods later believing they will be even cheaper.

Excess supply – More goods than people want to buy.

Increase in productivity – Technological advances can lower production costs and prices.

Tight monetary policy – High interest rates or limited money supply can reduce spending and investment.

Effects of Deflation:

Short-term benefit: Things become cheaper for consumers.

Long-term risk:

If business continue to have lower revenues then this can lead to job cuts or wage reductions.

Deflation causes lower consumer spending as consumer expect prices to fall further so they delay purchasing products.

Deflation may make existing debts harder to pay off as debt payments stay the same but wages may decrease. This may mean that interest payments may take up a higher portion of an individual’s income. Businesses may also find it harder to service debt as their revenue may have decreased but debt repayment are unchanged.

Deflation can also cause economic slowdown which can then lead to recessions or depressions.

Lauren Hua is a private client adviser at Fairmont Equities.

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