Question

Deflation refers to the phenomenon of a negative inflation rate. (In 2004, the inflation rate was negative in Hong Kong and we say Hong Kong suffered deflation in 2004.) Many people regard deflation as bad. Can you explain why? Is deflation sometimes good (at least for some people)? (400 words)

Answer 1

Deflation is a phenomenon in which, the prices of goods and services begin to fall. This usually happens when the total demand in an economy which is also known as the aggregate demand begins to fall. The end result is that the Gross Domestic Product or the total products produced in any economy begin to fall rapidly. This is because the profits of business owners decline sharply.

The core reason, as to why, deflation is said to be bad for an economy is because it creates a business cycle which cannot be corrected by the forces of demand and supply or independent market conditions. It requires serious intervention by the government int he form of reduced taxes or increased investment to resolve the same.

During a deflation, the demand for goods and service decline. As a result, producers begin to make losses and the prices of goods and services begin to fall. The resultant is that people are fired from their jobs and have even lesser money to be able to demand for goods and services. This cycle leads to long term issues and low growth rates in any economy and is thus considered to be bad for the economy,,

The deflation situation however, may be good for those who have lent out money. The consumer price index is the index which measures the changes in price level of goods and services. As this declines, people are able to buy more goods with the same amount of money.

Considering a loan of 500$ which were to pay a 10% interest rate, the normal rate of return would be 50 $ and the total return would be 550$ this amount however would be different from a year ago. We can now purchase more goods and services with the 550$ available thus increasing our rate of returns.