Causes & Consequences of Deflation (CIE IGCSE Economics)

With a decrease in output, fewer workers are required & so unemployment increases

With falling output & rising unemployment, households lose confidence choosing to save instead of spend. Consumption falls & rGDP reduces even more

Debt feels more burdensome as the value of any debt is worth more.  Real cost of borrowing increase as real interest rates rise when the price level falls e.g. if interest rates are 1.5% & the inflation rate is –1.5%, then the real interest rate is 3%

Falling output & falling prices cause firms to lose confidence & so they delay investment, further reducing rGDP

Falling output & falling prices reduce the profits of firms. Some firms will be unable to continue & will go out of business

Persistently falling prices can prove attractive to foreigners & the level of exports may increase (this helps offset some of the reduction in rGDP)

With a decrease in costs, the output of firms increases. More workers are required & so unemployment falls

With rising output & falling price levels, households become more confident & consumption increasing - increasing rGDP even more

Debt still feels more burdensome as the value of any debt is worth more  

Rising output & falling costs of production cause firms to gain confidence & increase investment, thereby increasing rGDP

Persistently falling prices boosts international competitiveness & exports increase