Leaving Cert: Consequences of deflation

TheWifeBeater

Hello,
Im a leaving cert economics student hoping for an A1 in wednesdays exam.I would really appreciate it if some one on this forum could give me maybe 5 or 6 consequences of deflation in the irish economy.

Much thanks,

Ronando

I'll get the ball rolling. Deflation encourages excessive saving, in the same way inflation encourages excessive borrowing.

When inflation is high, people are happy to borrow a fortune to buy a house, the fortune won't be a fortune in 10 years. (Similar logic led the losing governments in WW1 to inflate away their debt in the 1920s.)

When deflation occurs, people are happy to not consume and instead save their money, knowing they can get more bang for their buck in a year or two's time. Excessive saving destroys jobs, because no-one is buying, therefore less people have an income. In the housing market, for example, huge deflation is putting people off buying a home.

With deflation at -5% at the moment, real interest rates are about 7% - that's higher than at any point since the early 1990s.

Flamed Diving

In the context of the Irish economy, deflation can have positive effects, such as making housing affordable again. As it stands, house prices are too high as a ratio of the average wage. Once this normalises, we should see a clearing of the market again, and the construction sector should begin to pick up once again, meaning a lot of these layabouts getting off their arses and back to work.

TheWifeBeater

So does deflation encourage or discourage investment? I know high inflation creates a sense of uncertainty about the economy with investors which discourages them from investing(or so my book tells me) but is this the opposite of deflation?

Flamed Diving

TheWifeBeater wrote: »

So does deflation encourage or discourage investment? I know high inflation creates a sense of uncertainty about the economy with investors which discourages them from investing(or so my book tells me) but is this the opposite of deflation?

Its quite simple, actually. High inflation and high deflation both cause uncertainty about the economy. Deflation simply has the opposite effect to inflation. (At least for leaving cert economics anyway)

TheWifeBeater

Well thank ye VERY much for yere help lads.