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Deflation Answer Homework

Persistent deflation, characterized by low aggregate demand, can lead to high unemployment, business bankruptcies, and reduced economic growth for domestic stakeholders. It may prompt central banks to implement expansionary monetary policies, but these can result in lower foreign direct investment and a negative impact on the current account balance. If not addressed, the long-term consequences of malign deflation can severely undermine both domestic development and international competitiveness.

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6 views1 page

Deflation Answer Homework

Persistent deflation, characterized by low aggregate demand, can lead to high unemployment, business bankruptcies, and reduced economic growth for domestic stakeholders. It may prompt central banks to implement expansionary monetary policies, but these can result in lower foreign direct investment and a negative impact on the current account balance. If not addressed, the long-term consequences of malign deflation can severely undermine both domestic development and international competitiveness.

Uploaded by

dakshaanita
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

Option A:

Evaluate the consequences of persistent deflation for both domestic and


international stakeholders. [10]

Deflation refers to a consistent decrease in the general price level of an economy caused by changes
in demand and supply. Persistent deflation is likely to be a form of malign deflation which is caused
by low aggregate demand in relation to aggregate supply, which is detrimental to an economy’s
development.

For domestic stakeholders, deflation may lead to high levels of unemployment due to low levels of
demand. Businesses may face bankruptcies which will lead to lower output and mass layoffs This
reduces the confidence of economic agents and stagnates economic growth in the long-term.
Furthermore, as the profits of firms fall, so do their valuations, leading to a negative wealth and
equity effect for shareholders in the economy, discouraging investment as the economy may operate
below the optimum productive capacity outlined on the PPC curve, showing inefficient allocation of
resources. Due to higher unemployment levels, the government gains lesser tax revenue due to a
lower taxable population and a higher dependency ratio. This may exacerbate public sector debt and
the budget deficit for the country, lowering its international competitiveness.

Deflation may lead to expansionary monetary policies being implemented by the central bank by
lowering interest rates to incentivize spending in the economy. In the short-term, this impacts foreign
direct investments because of lower returns on deposits which might result in a flight of capital from
a country. Additionally, if malign deflation is persistent, it could lower the national output of a
country, making it uncompetitive in the export market in the long-term due to low supply to meet
foreign demand. This impacts the current account balance negatively. The longer that deflation lasts,
the level structural deficiencies in an economy rises. This is difficult to alleviate, affecting foreign
relations and trade deals.

While expansionary policies and automatic stabilisers may partially offset some negative effects,
persistent malign deflation poses serious long-term risks to both domestic growth and international
competitiveness, meaning its consequences could be severe if not addressed promptly.

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