Deflation
Demand-deficient deflation: BAD
Demand shifts left (down)
Consequences:
1. Increase unemployment,
2. falls in consumption + increased savings
3. Falling investment
4. Increased debt burden on households
Real interest rate rises when prices fall: real interest rate = nominal - inflation. If inflation is
negative then real interest rate rises - reducing consumption even more
spiral down: lay off workers, reduce income, reduce consumption, back again
Supply-side deflation: GOOD
• Due to lower costs of production, increased productivity
• Results: Lower prices: higher real income, lower unemployment, greater output
• Causes:
o Lower oil prices
o More productive labour force
o Appreciation of currency
o Lower minimum wage
o Better infrastructure
o Lower corporate taxes
Supply shift outwards (right)
Stagflation
An increase in inflation, combined with stagnant or negative growth + rising unemployment, caused by a
negative supply shock (left shift in SRAS)
• Will move the PC right