Question

Central banks commonly view fighting the possibility of deflation as a key priority.

a. Briefly describe why deflation makes recessions more painful.

b. Explain why deflation can be problematic for central banks.

c. How can a nation escape or avoid a deflationary spiral?

Answer 1

a) recession is a  significant decline in economic activity that goes on for more than a few months where as  a sustained, long-term downturn in economic activity in one or more economies. It is a more severe than a recession, which is a slowdown in economic activity over the course of a normal business cycle. employment, income, money supply, rate of interest, investment, consumer confidence, every thing is low in the economy so deflation makes recession more painful.

b) deflation is problamatic for central banks because in that period even if the rate of interest is cut down significantly, demand for money for investment purposes doesnot increase significantly drive the economy out of the rut. and this happens because of low consumer confidence and inventory stocks in the market. so even if central bank employs monetary policy to correct the situation it fails.

c)to escape a deflationary spiral government expenditure/investment is most essential. expansionary fiscal policy is the way to get out of the deflationary spiral.