Deflation

When the prices for Consumer Goods and the prices for other Assets decrease over time, this is Deflation. There is an increase in purchasing power. However, deflation could be a sign of deeper economic problems.

Deflation occurs in an Economy when the prices for goods and services as measured by the Consumer Price Index decline over a prolonged time period. CPI is a key leading economic indicator, designed to reflect price changes in the cost of living at the consumer level. The prices of consumer items as measured by basket of goods, can go up or down. During Deflationary periods, the cost of living in an economy is becoming cheaper, as the costs of goods or services will become less in the future. The purchasing power of the consumer increases, which could be viewed positively. The underlying causes of Deflation could be due to more ominous factors. A contraction money supply and credit in the economy.

The Central Bank will look to intervene during periods of price “instability” such as deflationary periods. If there is a contraction in the money supply, then the lowering of Interest Rates could be used, to stimulate credit flows in the economy and stabilise prices. Deflation could occur due to non-monetary or credit reasons. Increased productivity and improvements in an economy due to gains in technology could also lead to deflationary pressures. This is known as efficiency gains as companies can operate on a lower cost base. This can lead to increased profitability, due to competitive forces working in an economy. It is likely that consumers will also benefit with lower prices.