Deflation

Deflation is often described as a declining or decreases in prices. With inflation prices rise; with deflation they decrease. Deflation may occur when there is widespread unemployment or a decrease in the supply of money or credit. Since deflation represents the decreasing value of the dollar, it is often a precursor to an economic depression. For deflation to occur, the inflation rate must drop below 0% indicating that prices are no longer increasing but have in fact dropped into the negative.

The inflation rate measures price index and determines how much purchasing power the dollar has. The CPI or consumer price index monitors the changes found with consumer services and goods. The annual percentage the price market increases it is known as the inflation rate. When the price market index drops, so does the inflation rate. If it drops too low and enters negative numbers it is deflation. Deflation and disinflation are two separate things as disinflation describes a short period of falling inflation rates. Disinflation indicates a slowdown in the price index but doesn’t necessarily indicate a long period of negative economic trends is on the way. Deflation, however, is often followed by many negative outcomes that can lead to a full blown economic depression. It is important to note however, that deflation periods, may be short term and may not always lead to financial economic downturns, but deflation is always a cause for great concern.

You can also sum up deflation as a period in time when the supply of services and goods is higher than demand. Because of this prices drop and can set off a spiral of events that continues to have a negative impact on the economy. When deflation is evident in the land it is important to determine the cause of deflation and take immediate steps to rectify the situation. Some of the causes of deflation include a sense of fear or worry in the consumer market, reduced spending, increased debt and not repaying or taking out loans.

If consumers become afraid of spending money then their withholding of spending sets off a chain reaction increasing supply and reducing demand. When people are afraid to spend they often go into a mode of saving. As they continue to save their money less loans are initiated, credit cards are used less and the economy suffers. If this continues for long periods of time people will spend less money on goods and may even withhold making large purchases such as houses, new cars, or large appliances. Those who may want to open new businesses may choose not to do so for fear that the company will fail. When this occurs, companies, business owners and even the government will reduce prices to match the low demand and to try to unload the excess supply.

Deflation is extremely worrisome as many people will continue to keep their money in savings and stop spending. When this occurs companies and organizations stop spending money on production or creating new goods and services become limited. This greatly impacts production and when production comes to a halt, companies no longer need to keep workers on the job. Sometimes the company simply can’t afford to keep the worker employed. As job production halts, unemployment increases. Job layoffs increase debt and many bills, loans and credit goes unpaid. As this continues, financial investments lose value. Those who have built their portfolio in stocks, bonds and interest from banks lose their investments as the value of their investments decrease.

Another sector that loses value during times of deflation is real estate. As consumers stop buying the housing market takes a hit. Home prices drop and as more people are unemployed, lose their source of income and can no longer pay their debts more foreclosures arise. Those who have invested a portion of their financial portfolio in real estate may suffer tremendous loss in a quick time.

As deflation continues to ensue the government will step in and look for ways to redirect federal dollars to help make up the difference or ward off the greatest economic fallout. This can include reducing funds to much needed programs or even social benefits, welfare services and more. One of the greatest side effects of deflation, beyond the financial downfall, is the increase in crime. As more people lose jobs, income, their savings and investments the toll is not only financial but emotional as well. Depression increases and people deal with a level of unrest. This can result in an increase in crime.

When deflation occurs the best step is to take care of your own financial wealth by conserving your goods, reducing your debt and conserve your spending. Many choose to sell their stocks and bonds at the first signs of deflation to get the best price possible. Ensure that your money is in an FDIC insured bank and that you are not at risk of losing your cash. Preparing for deflation is one of the most important tools that one can use to protect his or her financial portfolio.