Question

What initial conditions would make it likely that a closed and open economy would fall into a deflation trap? .

Answer 1

Deflation can be brought about by a mix of various variables, including having a lack of cash available for use, which builds the estimation of that cash and, thus, diminishes costs; having a bigger number of products delivered than there is interest for, which implies organizations must diminish their costs to get individuals to purchase those merchandise; not having enough cash available for use, which causes those with cash to clutch it as opposed to spending it; and having a diminished interest for products by and large, subsequently diminishing spending.

Naturally, falling prices can also occur when the economy's production grows faster than the supply of money and credit which circulates. It is especially true as technology improves an economy's competitiveness, and is therefore concentrated in products and sectors that benefit from technological changes. Companies work more effectively while developing technology. Such operational changes lead to lower manufacturing costs and cost savings in the form of lower prices being passed to customers. This is distinct but similar to general market deflation, which is a general decrease in price level and an rise in money's buying power.

By through interest rates, a central bank can use a more stable monetary policy. And people tend to save more of it instead of wasting their money immediately. Rising interest rates often contribute to higher borrowing costs, which also discourages economic spending.

Negative economic events, such as recession, may also cause aggregate demand to decline. During a recession, for example , people may become more pessimistic about the economy's future. They consequently choose to increase their investments and reduce current expenses.