What is deflation? Causes and consequences of deflation
Long-term discounts on goods help users buy more products for the same amount of money. At first glance, it seems to bring many benefits, but in fact it causes many impacts on the economy. The term for this is called deflation.
What is deflation?
Deflation is a phenomenon in which the prices of goods and services fall over a long period of time, making cash worth more purchases. That is, with an amount of cash, consumers can buy more products than before deflation. 
What is the cause of deflation?
Deflation is often associated with a decrease in overall demand in the economy. To make it easier to understand, we can consider the example of Japan's deflation in the 1990s, often called the "Lost Decade".
Below are three main causes of deflation.
- Decreases in consumer demand and investment
When consumers and businesses decide to save instead of spending and investing due to concerns about the economic situation, overall demand decreases. As a result, to stimulate consumption and investment, prices of goods and services may decrease, leading to deflation.
After Japan's real estate and stock bubble burst in the late 1980s, consumer and business confidence plummeted.
Consumers become cautious and prioritize saving over spending. Meanwhile, businesses reduce investment due to unclear economic prospects.
This causes product prices to drop sharply, contributing to prolonged deflation.
- Increased productivity and technological advancement
Increased productivity and technological advances reduce the cost of producing goods and services. In some cases, this leads to a decrease in product prices, a cause of deflation.
While this is a positive factor in the long run due to increased economic efficiency, it can cause deflation in the short term if prices fall more sharply than income increases.
During this time, Japan continued to see technological advances, especially in the fields of manufacturing and information technology. This helps reduce production costs.
Therefore, product supply on the market is higher than actual demand, many companies have reduced product prices to attract users, increasing deflation.
- Contractionary monetary policy
When central banks raise interest rates or adopt policies to shrink the amount of money in circulation, borrowing and spending become more difficult. This causes market demand and prices to decrease, causing deflation.
The Bank of Japan, in an initial attempt to prevent asset bubbles, adopted a contractionary monetary policy, including raising interest rates. This has increased loan interest rates and reduced credit demand, directly affecting investment and consumption.
Although the Bank of Japan later tried to reduce interest rates to stimulate the economy, these measures were not strong enough to completely reverse the deflationary trend.
How to deal with deflation?
The consequences of deflation cause negative impacts on the economy, including:
- Reduce investment
- Increased debt burden
- Reduce consumption
- Impact on employment
- Reduce the effectiveness of monetary policy
To cope with deflation and limit its negative consequences, countries can apply a combination of measures as follows:
- Loose monetary policy: Central banks can reduce interest rates to encourage borrowing and investment, strengthening overall demand in the economy. In addition, implementing quantitative easing policies can help increase the amount of money in circulation and promote spending.
- Expansionary fiscal policy: Increase public spending and reduce taxes to stimulate demand and create jobs, improving economic growth.
- Intervention in the currency market: Preventing the increase in the value of the national currency, improving the situation of exports and reducing imports, increasing domestic demand.
