Deflation is a harmful situation for the economy of a nation. It results in intense damage and the long-term effects can also be observed. Amongst all the effects of deflation, the prominent ones are reduction in the business revenue, reduction in wages, modifications in the patterns of customer spending, and decrease in credit.
Let us discuss in detail some of the effects of deflation.
Effect One – Reduction in the business revenues
Companies need to decrease their prices in a competitive manner. But due to severe competition in the industry, companies go on reducing their prices. As a result, it hampers the revenue generation capacity of the companies. Thus, during the period of deflation, the revenues of the business organization affect adversely.
Effect Two – Reduction in the wages and unemployment
As the revenue of the business organizations decreases considerably, they try to cope up with deficiencies by cutting the wages of workers. They reduce the salaries of employees and cut off the bonus and incentive systems. Moreover, if they feel that some of the positions are unnecessarily filled, then they reduce the number of positions. This results in reduction of the would-be customers in future. It has a significant impact on the unemployment.
Effect Three – Reduction in the patterns of consumer spending
The relationship between deflation and the consumer spending patterns is difficult to understand and predict as well. Initially, the consumers increase their spending activity as the prices of the commodities are reduced by the companies. But after a certain period of time, the companies implement some measures to increase their revenue by cutting of wages and numerous positions. This results in unemployment and reduction in salary structure. As a result, the consumers spend less. The reduced consumer spending has the worse effect on the conditions of deflation in the country.
Effect Four – Reduction in the investment structure
One can easily predict the effect of inflation on the investment portfolios of the investors. Due to unemployment and less wage structure, consumers will find it difficult to get the essential commodities. They will prefer to meet their ends meet instead of making investments. Since companies are already undergoing losses, the stock market will not portray a good picture of the same. Hence, customers will not invest in the share market. Due to reduction of interest rates by banking systems for fighting against deflation, investment will suffer. Thus, consumers will try to hold cash instead of investing it.
Effect Five – Reduction in credit
With the dawn of deflation, lending institutions try to reduce the interest rates but the customers will not be in a position to borrow. The reduction in credit calls for more deflation.
The long-term and adverse effects of deflation are many. The deflation and its effects can be reduced with a disciplined approach by the economy of the nation. The deflation cannot be reduced by itself. In the beginning, customers may feel that the price reduction is good for them to make purchases. But at later stage, the adverse impact of deflation is witnessed in the form of unemployment and less wage structure.
Deflation is a macroeconomic theory where there is a reduction in price levels. Apart from all the adverse effects of deflation, such as fall in prices, increased unemployment, reduction n credit and so on; one good thing that deflation brings in is the increased purchasing power. The consumers can buy more while making a lower payment during deflation.
Though people will have increased purchasing power - that may not be useful while you’re unemployed or your business is struggling. This is why it is important to safeguard yourself against the effects of deflation by having a lot of savings and assets that you can rely on in a time of need!
The effects of deflation sounds like a giant monster eating all our happy times. Price reduction, reduce interest rates look attractive but the very thought of unemployment, salary, bonus, incentive reduction sends goosebumps. With right monetary policies the situation can be avoided to certain extend.