What It Means For Global Economies & Corporates
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WHAT’S SO BAD ABOUT DEFLATION?
In contrast to inflation, where the general level of prices rises, encouraging consumption and investment, deflation discourages both, as savers hoard cash with the expectation that prices will fall, and their unwillingness to spend causes prices to do just that. The result is a downward spiral in activity, which, if severe enough, can lead to depression, as was seen throughout much of the world in the 1930s.
“The worry is if there’s a widespread decline in activity,” observes Kevin Logan, chief US economist for HSBC. “We’re on the edge of it.”
Some observers distinguish between “good” and “bad” deflation and point to the positive impact of falling oil prices as an example of the first, at least to the extent that the decline puts more money in the hands of consumers and encourages them to boost their spending. The US Federal Reserve has embraced that view, at least in its public pronouncements.
To the extent oil’s price decline is related to demand, it is mostly an effect rather than a cause of deflation. Still, there’s concern that it can feed deflation as well by putting downward pressure on manufacturers’ prices.
In that sense, the distinction between good and bad deflation may ultimately be a false one. “People are right to be concerned about deflation,” concludes Fergus McCormick, head of sovereign ratings for credit rating firm DBRS.