Paul Buckley ‘17
With ongoing geopolitical issues taking place in the Ukraine and Middle East, it’s been easy to overlook the ongoing financial crisis hitting the Eurozone. Consumer prices in the 18-nation union have recently hit 5 year lows and ultra-low inflation rates with the potential to cause deflation. This is making investors wary and bringing up talks of a potential end to the Euro as we know it.
Inflation and deflation and all the sub sectors that reside within those two, are a huge part of daily life. These two phenomenon affect our lives on a daily basis, however it is easy to ignore their causes and potential for economic devastation or growth.
Inflation is, by definition, the rate at which the general level of prices steadily increases over a period of time. While there is no single cause contributing to inflation, there are two theories into why inflation occurs: the demand-pull and cost-push theories. In simplistic terms, demand-pull is attributed to higher demand for a limited supply of goods, which causes the price to rise. Cost-push deals with higher prices as a result of higher production costs (due to taxes, raised wages, raw material price, etc.) Now while a rise in prices may seem bad and the increase drastic, inflation isn’t necessarily a bad thing as it affects people in different ways. In fact, it is often viewed as a sign that the economy is growing. The key is to try and contain inflation at a steady rate instead of letting it grow too high (hyperinflation) or decrease (disinflation) and run into the possibility of falling into the negatives (deflation.)
Now deflation, as previously mentioned is the current issue that’s ravaging the Eurozone. Where inflation is a rise in prices, deflation is a decline in the general level of prices or a decline in CPI (consumer price index) leading to negative inflation. Declining prices have a number of economical issues that can result in lost profits to corporations, contraction of assets, shrinking employment, and lower wages to name a few.
The threat of lower prices can cause consumers to sit on their cash in hopes of purchasing goods at a lower cost. If something is currently worth $100 and we’re dealing with the potential of 10% deflation, wouldn’t you rather wait and buy it at the cheaper $90? Now this becomes dangerous because consumer prices are falling as a result of lower spending. To counteract that, companies could lower their prices, which minimize the profit margin, meaning less money that can be reinvested back into the company to help it grow. When you have thousands of companies being forced to do this, you can face the real possibility of slowed economic growth.
To sum it all up in terms of deflation: when prices of goods and services decline, consumers do not buy, as they will want to wait for further price declines. This in turn leads to an increase in inventory for the producer, reduced prices and production, and lay-offs. When this happens a company starts losing income as the demand for the products decreases and ultimately because of low demand, lower production, higher unemployment and a decrease in GDP on a macro scale.