Deflationary Spiral : How it affects business ?

Group Members: Akhil Naveen Nithin Parvathi Pritika Surej Yadhav Gayathri Dona
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Inflation hurts, but Deflation could be worse

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Introduction

Economic occurrence where the inflation rate is negative and continuing to decrease. Occurs when prices and wages drop and slows inflation due to lower demand (and therefore, lower production). Supply of money usually decreases, leading to a stronger currency that would fuel even lower prices and wages, thereby creating a chain of events. Deflationary spirals are often viewed negatively because they generally occur in recessionary times and tend to worsen the recession.
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What happens during deflation ?

During deflationary times, money increases in its "buying" or "purchasing" power, and it takes less units of currency to purchase the same units of goods or services. Over time, deflation increases the value of each unit of currency.

Many economists regard deflation as more dangerous than inflation.

It prompts consumers to delay purchases as they wait for lower prices, creating a downward spiral of lower demand and production.

Causes of deflation

Capitalism characterized by sufficient existence of competition. Decrease in the money supply.

Increase in the supply of goods.

Fall in the demand for goods. Escalation in the demand for money.
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Example: Japan Crisis

Deflation started in the early 1990s. The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing.

Deflation persisted till 2006.

Causes for deflation in Japan

Tight monetary conditions.

Unfavorable demographics.
Fall in asset prices. Insolvent banks.

Imported deflation.
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How Deflation affects Business?

If deflation persists, businesses may shut down or reduce their production.

As a result, unemployment may increase and wage rates may fall. The spiralling effect of deflation on prices and wages may create pessimism, and the economy could fall into a recession. Unfortunately, this leads to less production at factories, less investment and a so-called deflationary spiral.
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Many individuals and businesses are choosing to pay down debt rather than spend. When owners and people believe that they are responsible, they actually slow down the economy by not spending or expanding their workforce. This process tends to run in a loop, where a consumer will pay down debt rather than spend, and a business will see its sales decline forcing it to layoff workers who will not spend, reducing the wealth of business further

If deflation persists, businesses will not invest in new ventures.

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Measures to Control Deflation

1. Reduction in Taxation 2. Redistribution of Income 3. Repayment of Public Debt

4. Subsidies
5. Public Works Programme:
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6. Deficit Financing
7. Reduction in Interest Rate 8. Credit Expansion 9. Foreign Trade Policy

10. Regulation of Production

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Conclusion

While inflation erodes the value of money, which progressively buys less and less per unit, deflation makes money worth more. This makes people and businesses less likely to spend it . Consumers because they expect even better deals if they wait, and businesses because its less profitable to produce goods or services that will bring a lower real return. These factors can feed on each other to produce a downward economic spiral, as happened in the Great Depression. Deflation, the falling of prices throughout an economy, is not a good thing. It only enters the picture in bad times, as a threat to make things worse.
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References

http://www.epw.in/global-economic-and-financial-crisis/what-driving-globaldeflation-and-how-best-fight-it.html http://www.epw.in/commentary/deflation-devaluation-and-employment.html Http://www.epw.in/special-articles/japanese-economic-recovery-andmacroeconomic-policy-mix.html http://www.epw.in/commentary/implosion-japanese-capitalism.html http://economics.about.com/b/2007/12/03/is-deflation-necessarily-a-badthing.htm

http://www.preservearticles.com/201012281832/control-of-deflation.html
http://www.money-zine.com/Investing/Investing/Inflation-and-Deflation/

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THANK YOU
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