Deflation, a general drop in price levels, is a multi-layered economic phenomenon that can have both positive and negative consequences for economies. While price reductions based on efficiency increases led to prosperity and growth in certain historical epochs, the causes and effects of modern deflation are much more complex andoften problematic. The following will examine the different forms of deflation, its causes, the consequences for different social groups and the reactions of politics and central banks in detail.
Historical Perspective: Efficiency-driven price reductions in the 19th century
In the 19th century, many industrialized countries experienced a phase in which technical progress and productivity increases led to falling prices. However, these price reductions were not an expression of an economic crisis, but rather the result of innovations, improved production methods and increasing efficiency. During this time, stable or even rising wages went with a strongeconomic growth. The so-called “positive deflation” ensured that the purchasing power of the population increased, investments remained worthwhile and consumption flourished. The economy benefited from a dynamic focused on progress and prosperity.
Modern Deflation: Causes and Dynamics in the 20th and 21st Century
In contrast, the price reductions of deflation in the present are mostly due to structural weaknesses. The focus here is on a lack of demand, high level of debt and the bursting of speculative bubbles. Companies are confronted with falling profit expectations and are postponing investments, as they hardly promise any returns. Consumers, in turn, are waitingPurchases because they hope for further falling prices. This downward spiral causes the economy to stagnate or even shrink.
The Downward Spiral: Consequences of Negative Deflation for Economy and Society
The effects of negative deflation are serious. Companies reduce investment and cut jobs, resulting in rising unemployment and falling income. Consumption is falling, demand for goods and services is falling, and state tax revenue is decreasing. The total economic performance is shrinking, which is in a severeeconomic crisis and often also in a stock market crisis. This is particularly problematic for highly indebted states, companies and private households: while prices, profits and wages are falling, the nominal value of the debt remains constant. The real debt burden is increasing, which drives many debtors into insolvency.
Deflation winners and losers: who benefits, who suffers?
In a deflationary phase, owners of financial assets in particular benefit, as the purchasing power of their capital increases. For the debtors, on the other hand, the situation is getting worse: You must continue to serve your loans in full, although your real income and assets are falling. Insolvencies are increasing, jobs are being lost, and the economy is spiraling down. so-calledDebt deflation is further strengthening this development as companies and households are trying to reduce their debts through austerity measures, which further weakens demand and deepens the crisis.
Central banks and politics: measures against the risk of deflation
Given the negative consequences of deflation, governments and central banks are trying to counteract monetary and fiscal policy measures. Former US Federal Reserve President Ben Bernanke and many of his colleagues rely on expansive monetary policy and quantitative easing, i.e. the massive purchase of government bonds and securities by central banks. The aim was to increase the economyto revitalize and prevent deflation. But despite these measures, success was limited: Many people’s real incomes continued to fall, while wealth owners in particular benefited from rising prices. The broad population felt little of the positive effects of the glut of money.
The financial crisis from 2007: Deflation as a real threat
With the outbreak of the financial crisis from 2007 onwards, the risk of deflation was recognized worldwide. The measures taken – bank rescues, economic stimulus programs and massive public debt – were able to prevent a collapse, but led to new problems. The debt burden of the states increased dramatically, while the middle class suffered from stagnant or falling incomes. in Japanit was particularly clear that even extensive monetary policy measures did not necessarily lead to inflation: Despite decades of quantitative easing, the price level remained low and the economy stagnated.
Demographic and structural challenges
Demographic development is an often underestimated factor in the deflation debate. The aging population in many industrialized countries leads to a restrained consumer behavior, which further weakens demand. Central bank models often underestimated these effects, leading to misjudgments in the effectiveness of monetary policy. rise at the same timethe state and central bank debts, which increases the risk for the entire financial system.
Speculative Blisters and Asset Deflation
The bursting of speculative bubbles, for example in the real estate sector, has repeatedly led to asset deflation in recent decades. This is particularly problematic when assets are loan-funded: falling prices lead to over-indebtedness, loan defaults and burdens on banks. New loans are decreasing, the money supply is shrinking, and consumption is increasingbraked. In the US, for example, private households are saving and reducing debt, which further increases deflationary tendencies.
Real income, living expenses and middle class
Although official statistics sometimes show impressive growth figures, many citizens feel a real decline in their income. The middle class is shrinking while the cost of rent, health care, education and municipal fees is increasing – often without sufficient consideration in the official inflation figures. This development reduces disposable incomeand reinforces deflationary tendencies. The economist Heiner Flassbeck describes this development as “debt deflation” that is triggered by speculative exaggerations and the bursting of bubbles.
Globalization, market liberalization and geopolitical influences
The increasing market liberalization and globalization also contribute to deflation. Free trade agreements such as TTIP and the shifting of jobs to low-wage countries are putting pressure on prices and promoting deflationary developments. Economic sanctions, such as against Russia, can reinforce this effect by further weakening demand and increasing uncertainty.
Central Bank Interventions and the Future of the Financial System
Without the massive interventions of central banks – such as the Federal Reserve, the European Central Bank and the Bank of Japan – the world economy would probably have slipped into long-lasting deflation long ago. To prevent a collapse, these measures are expected to continue for a few more years. Small interest rate hikes often only serve to gain confidence in monetary policysignal, but are not always based on reliable data. The risks of this policy are significant: even small increases in interest rates can have dramatic consequences, including state insolvency, in view of the high level of debt. In addition, a crisis of confidence in the major currencies Yen, Euro and US Dollar is threatened, with the US dollar being likely to lose value as the last major currency.
Outlook: Risks, opportunities and recommendations for action
Demographic factors appear more important in the long term than short-term monetary policy measures. The example of Japan shows that even massive money pressure programs do not necessarily lead to inflation. Inflationary risks will be low in the next few years, but in the medium to long term the probability of hyperinflation, economic collapse and possiblecurrency reform. In this environment, cash remains “King” for the time being. Investors should selectively invest in solid, non-cyclical or anti-cyclical stocks and consider long-term bonds from solvent issuers. As soon as the environment changes from deflation to inflation, it is advisable to re-subscribe to sustainable values in good time, which also exist in an inflationary climate.
Conclusion: complexity of deflation and the challenges for the future
The economic relationships surrounding deflation are extremely complex. The previous monetary policy measures were only able to solve the fundamental problems to a limited extent. The challenges remain great and the coming years will be crucial to the stability of the global economic system. A clever combination of structural reforms, responsible monetary policy is requiredand a realistic assessment of demographic and social developments to cope with the risks of deflation and to take advantage of the opportunities for sustainable growth.
