HomeIndustriesFinanceDeflation: Definition, Types, and How to Deal with It

Deflation: Definition, Types, and How to Deal with It

In economics, there is a very popular term, namely deflation. Do you know the meaning of this term? In general, deflation means a period where the prices of goods in general decrease and the value of money increases. The prolonged deflation will certainly make buying and selling activities experience losses, and a country’s economy becomes unstable. This article will provide information to the readers about deflation, including the definition, types, and how to deal with it.

The Expert Definition of Deflation

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Several well-known experts expressed their opinions in defining deflation. One of them is Stacia E. H. Sitohang, an expert from Indonesia. According to her, deflation is the opposite of inflation, where the price of an item generally decreases.

According to Investopedia, deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy.

Also read: Economic Activity | Definition, Type, Actors, Characteristics, Goals

The Types of Deflation

Deflation can be categorized into two types, strategic and circulation deflation. Here is the explanation of each type of deflation:

Strategic deflation

This type of deflation can occur due to the establishment of monetary policy by the government related to controlling the symptoms of consumption that is considered excessive in the community. Where the occurrence of excessive consumption can suppress the increase of the product price in the market. This policy does not suppress the excessive consumption among the public, but it impacts on the price decline that will make the consumption increase in the public.

Strategic deflation is caused by policies implemented by the government and central banks to reduce the interest rates. This policy will make it easy for consumers to get a number of loans from the bank. In addition, manufacturers will keep the money they have in the bank to get a large amount of interest. This will certainly make the money circulation and the price of goods decrease.

Circulation deflation

This type of deflation arises because of the unstable economic conditions of a country. Circulation deflation occurs when the transition period of a stable economy is experiencing a slump. Situations like this will certainly make the public worried.

Circulation deflation begins from a significant decrease in people’s needs for economic goods. In addition, there is also the production of the same types of goods in similar quantities that are said to be excessive. Later on, this may cause a drastic decrease in goods prices.

The Impact of Deflation

The occurrence of deflation in a country will certainly have its impact. In this case, the impact of deflation can be either a positive impact or a negative impact. Here is an explanation of each of these impacts of deflation:

Positive impact

Deflation has some positive impacts on a country. The occurrence of deflation will strengthen the value of the currency and also give awareness to the public about the importance of saving. Saving activities will certainly provide convenience for someone in fulfilling their needs in the future. In addition, deflation will make the public as a consumer save their money when shopping for various needs. 

Negative impact

The occurrence of deflation in a country will certainly have various negative impacts. Revenue from a company or business will decrease due to deflation. Later, this will be a domino effect to others, such as massive job layoffs and an increasing unemployment rate. In addition, deflation will cause a decline in stock prices and other investments.

Also read: Overcoming Economic Downturn for Companies

Causes of Deflation

Several things can cause deflation. Here are the causes of deflation:

Decrease of money circulation

The money circulation among the public will decrease along with the offer of high-interest rates from banks. Many people will keep some money in the bank because of this offer.

Increase of goods supplies

The goods supplies will increase due to the high amount of demand in the market. Of course, the increase of goods supplies will cause deflation in a country. 

Implementation of policies from the government or central bank

The government or central bank implemented policies are also a factor in the occurrence of deflation. In this case, if the central bank implements policies related to high-interest rates, the public will keep some of their money in the bank. Of course, this will decrease the money circulation in the community.

Production of similar types of goods

Companies will compete to increase the production of similar types of goods to reach many consumers. Later on, the company will use various strategies to keep prices as low as possible. This will certainly be a contributing factor to deflation.

Decrease in production demand

The manufacturer does not implement an accurate calculation of the production amount in producing a large number of products. Therefore, the manufacturer can organize the production amount to match the demand from the consumer.

Also read: Liquidity is: Know the Benefits and How to Calculate Them

How to Deal with the Deflation

Various ways can be done to deal with the occurrence of deflation in a country. Here are some ways that can be implemented to deal with deflation:

Lower interest rates

With high-interest rates, people will keep their money in the bank. This will certainly cause deflation because money circulation decreases. Therefore, it is necessary to reduce interest rates so that the money circulation will increase.

Monetary policy implementation

Central banks often carry out this policy in order to increase the money circulation among the public. With this monetary policy, there will be a discount rate policy. This is a step in decreasing the interest rates. So that people will withdraw their money from the bank.

Fiscal policy implementation

The government plays a role in determining the right fiscal policy to maintain the economic conditions of a country in a better way. This can be done by renewing the existing expenses.

Non-monetary policy implementation

The non-monetary policy is the right way in order to increase the money circulation among the public. With this, deflation can be stopped immediately.

Tips When the Deflation Occurs

When inflation occurs, there are some tips that you can do. Here are some tips that can be done when deflation occurs:

Pay all debts

When deflation occurs, interest rates will increase. Later, this will lead to a high cost of credit. Therefore, you need to pay all debts when deflation occurs immediately.

Prepare an emergency fund

Deflation that occurs in a country will certainly impact the company or business bankruptcy to job losses. It is essential to prepare an emergency fund for 6-7 months of expenses that you do. An emergency fund can guarantee that you will not experience economic difficulties when deflation occurs in a country. 

Shopping if necessary

When deflation occurs, there will be conditions that the prices of the goods will decrease. However, you have to commit to buying any items or needs that are important. It is better to save money as a preventive way in facing unpredictable economic conditions.

Do some investment activities

You must be able to look for all opportunities that exist in investment when deflation occurs. Doing asset investment becomes a recommendation for you in doing investment activities when deflation occurs. This is because asset investments are more liquid and have a low-risk level compared to others.

Do a side job

A side job or side business is a job that can be carried out besides the main activities to get an additional income. This might be a solution to raise some money when deflation occurs.

Related article: Get to Know the Definition and Best Ideas of Side Business

The Distinctions between Deflation and Inflation

The terms of deflation and inflation are both related to each other. But they have major distinctions. Talking about the definition, deflation can be defined as a condition where the prices of goods decrease continuously in a certain period. Meanwhile, inflation has an understanding as a condition where there is an increase in goods prices that occurs over a long time.

Then the next distinctions can be see from the cause of it. If deflation is cause by the decrease of money circulation among the public, while inflation is cause by increasing money circulation among the public.

Meanwhile, the other distinctions between these two terms can be seen from their impact. The occurrence of deflation will trigger various things like an increase in the unemployment rate. Meanwhile, the impact of inflation is the decrease of purchasing activities in the community.

All aspects mentioned above can make it easier to distinguish the terms deflation and inflation.

Examples of Deflation

Speaking of the deflation examples, Indonesia has experienced deflation due to decreased fuel oil prices, which was initially Rp 8,500 / liter to Rp 7,500 / liter on January 1, 2015. Then, there was a second decrease in fuel oil prices to Rp 6,600 / liter on January 16, 2015. The decrease in the fuel oil prices occurred because the world oil price at that time slumped to $ 50 / barrel.

Conclusion

Deflation is a condition where there is a decrease in the prices of the goods along with an increase in the currency value in a country in some period. The occurrence of continuous deflation will certainly make the economic condition of a country unstable. A number of ways can be done to prevent deflation, from implementing fiscal policy to reducing interest rates policy. Furthermore, people also have good financial planning in anticipating the deflation in their country. One of them is by preparing an emergency fund that the amount is 6 to 7 times expenses.

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