Editing Deflation (section)

==Causes and corresponding types==
{{more citations needed section|date=November 2014}}
In the [[IS–LM model]] (investment and saving equilibrium{{snd}}liquidity preference and money supply equilibrium model),<ref>{{Cite journal |last=Hicks |first=J. R. |date=1937 |title=Mr. Keynes and the "Classics"; A Suggested Interpretation |url=https://www.jstor.org/stable/1907242 |journal=Econometrica |volume=5 |issue=2 |pages=147–159 |doi=10.2307/1907242|jstor=1907242 |url-access=subscription }}</ref><ref>{{Cite journal |last=Meade |first=J. E. |date=1937 |title=A Simplified Model of Mr. Keynes' System |url=https://academic.oup.com/restud/article-lookup/doi/10.2307/2967607 |journal=The Review of Economic Studies |volume=4 |issue=2 |pages=98–107 |doi=10.2307/2967607|jstor=2967607 |url-access=subscription }}</ref><ref name=":0">{{Cite book |last=Blanchard |first=Olivier |title=Macroeconomics |date=2021 |publisher=Pearson |isbn=978-0-13-489789-9 |edition=8th |location=London |publication-date=2021 |language=en}}</ref> deflation is caused by a shift in the supply and demand curve for goods and services.{{cn|date=April 2024}} This in turn can be caused by an increase in supply, a fall in demand, or both.

When prices are falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity. When purchases are delayed, productive capacity is idled and investment falls, leading to further reductions in [[aggregate demand]]. This is the deflationary spiral. The way to reverse this quickly would be to introduce an [[Stimulus (economic)|economic stimulus]]. The government could increase productive spending on things like infrastructure or the central bank could start expanding the [[money supply]].<ref name=":0" />

Deflation is also related to [[risk aversion]], where investors and buyers will start hoarding money because its value is now increasing over time.<ref name="Hussman2010">{{cite web | last1 = Hussman | first1 =John O. | title = Bernanke Leaps into a Liquidity Trap | year = 2010 | url = http://www.hussmanfunds.com/wmc/wmc101025.htm }}</ref> This can produce a [[liquidity trap]] or it may lead to shortages that entice investments yielding more jobs and commodity production. A central bank cannot, normally, charge negative interest for money, and even charging zero interest often produces less stimulative effect than slightly higher rates of interest. In a [[autarky|closed economy]], this is because charging zero interest also means having zero return on government securities, or even negative return on short maturities. In an open economy, it creates a [[Carry (investment)|carry]] trade and devalues the currency. A devalued currency produces higher prices for imports without necessarily stimulating exports to a like degree.

Deflation is the natural condition of economies when the supply of money is fixed, or does not grow as quickly as population and the economy. When this happens, the available amount of hard currency per person falls, in effect making money more scarce, and consequently, the [[purchasing power]] of each unit of currency increases. Deflation also occurs when improvements in production [[efficiency]] lower the overall price of goods. [[Competition]] in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods, and consequently, deflation has occurred, since purchasing power has increased.

Rising [[Productivity improving technologies (historical)|productivity]] and reduced transportation cost created structural deflation during the accelerated productivity era from 1870 to 1900, but there was mild inflation for about a decade before the [[Federal Reserve Act|establishment of the Federal Reserve]] in 1913.<ref name="Wells1890"/> There was inflation during [[World War I]], but deflation returned again after the war and during the 1930s depression. Most nations abandoned the [[gold standard]] in the 1930s so that there is less reason to expect deflation, aside from the collapse of speculative asset classes, under a [[Fiat money|fiat monetary system]] with low productivity growth.

[[File:CPI 1914-2022.webp|thumb|alt=CPI 1914-2022|upright=1.8|American CPI 1914-2022{{legend|#0076BA |[[Inflation]]}}
{{legend|#EE220C |Deflation}}
{{legend-line|#1DB100 solid 3px|[[Money supply|M2 money supply]] increases year/year}}
]]
In [[mainstream economics]], deflation may be caused by a combination of the supply and demand for goods and the supply and demand for money, specifically the supply of money going down and the supply of goods going up. Historic episodes of deflation have often been associated with the supply of goods going up (due to increased productivity) without an increase in the supply of money, or (as with the [[Great Depression]] and possibly Japan in the early 1990s) the demand for goods going down combined with a decrease in the money supply. Studies of the Great Depression by [[Ben Bernanke]] have indicated that, in response to decreased demand, the Federal Reserve of the time decreased the money supply, hence contributing to deflation.

Causes include, on the demand side:
* Growth deflation
* Hoarding

And on the supply side:
* Bank credit deflation
* Debt deflation
* Decision on the money supply side
* Credit deflation

===Growth deflation===
Growth deflation is an enduring decrease in the real cost of goods and services as the result of technological progress, accompanied by competitive price cuts, resulting in an increase in aggregate demand.<ref>{{Cite journal |last1=Beckworth |first1=David |title=Aggregate Supply-Driven Deflation and Its Implications for Macroeconomic Stability |journal=Cato Journal |volume=28 |issue=3 |publisher=Cato Institute |url=http://www.cato.org/pubs/journal/cj28n3/cj28n3-1.pdf |url-status=dead |archive-url=https://web.archive.org/web/20111009235909/http://www.cato.org/pubs/journal/cj28n3/cj28n3-1.pdf |archive-date=2011-10-09 }}</ref>

A structural deflation existed from the 1870s until the cycle upswing that started in 1895. The deflation was caused by the decrease in the production and distribution costs of goods. It resulted in competitive price cuts when markets were oversupplied. The mild inflation after 1895 was attributed to the increase in gold supply that had been occurring for decades.<ref>{{cite book|title=The Cost of Living in America: A Political History of Economic Statistics, 1880-2000 |last=Stapleford |first= Thomas|year= 2009|publisher =Cambridge University Peess|pages=69–73}}
</ref> There was a sharp rise in prices during World War I, but deflation returned at the war's end.  By contrast, under a fiat monetary system, there was high productivity growth from the end of [[World War II]] until the 1960s, but no deflation.<ref>{{Cite journal | last1 = Kendrick | first1 = John | title = U.S. Productivity Performance in Perspective, Business Economics, October 1, 1991 | year =1991 | url = http://www.allbusiness.com/finance/262030-1.html }}</ref>

Historically not all episodes of deflation correspond with periods of poor economic growth.<ref>Andrew Atkeson and Patrick J. Kehoe of the Federal Reserve Bank of Minneapolis [https://www.minneapolisfed.org/research/sr/sr331.pdf Deflation and Depression: Is There an Empirical Link?] {{Webarchive|url=https://web.archive.org/web/20160506171400/https://www.minneapolisfed.org/research/sr/sr331.pdf |date=2016-05-06 }}</ref>

Productivity and deflation are discussed in a 1940 study by the [[Brookings Institution]] that gives productivity by major US industries from 1919 to 1939, along with real and nominal wages. Persistent deflation was clearly understood as being the result of the enormous gains in productivity of the period.<ref>{{Cite book| last1 = Bell| first1 = Spurgeon| title = Productivity, Wages and National Income, The Institute of Economics of the Brookings Institution| year = 1940|publisher=Waverly press}}</ref> By the late 1920s, most goods were over supplied, which contributed to high unemployment during the Great Depression.<ref name="Beaudreau1996">{{Cite book|title=Mass Production, the Stock Market Crash and the Great Depression |last=Beaudreau |first=Bernard C. |year=1996 |publisher=Authors Choice Press|location=New York, Lincoln, Shanghi }}</ref>

===Bank credit deflation===
Bank credit deflation is a decrease in the bank credit supply due to bank failures or increased perceived risk of defaults by private entities or a contraction of the money supply by the central bank.<ref>Carapella, Francesca (2015). "Banking panics and deflation in dynamic general equilibrium". Finance and Economics Discussion Series 2015-018. Washington: Board of Governors of the Federal Reserve System. {{doi|10.17016/FEDS.2015.018}}.
</ref>

===Debt deflation===
{{Main|Debt deflation}}
Debt deflation is a phenomenon associated with the end of long-term credit cycles. It was proposed as a theory by [[Irving Fisher]] (1933) to explain the deflation of the [[Great Depression]].<ref>{{cite journal|url=https://fraser.stlouisfed.org/title/3596|title=The Debt-Deflation Theory of Great Depressions |journal=Fraser|location=St Louis, Missouri|publisher=Federal Reserve|date=October 1933 |last1=Fisher |first1=Irving }}</ref>

===Money supply-side deflation===
From a monetarist perspective, deflation is caused primarily by a reduction in the [[velocity of money]] or the amount of [[money supply]] per person.

A historical analysis of money velocity and [[monetary base]] shows an inverse correlation: for a given percentage decrease in the [[monetary base]] the result is a nearly equal percentage increase in money velocity.<ref name="Hussman2010"/> This is to be expected because monetary base ({{math|{{var|M}}{{sub|{{var|B}}}})}}, [[velocity of money|velocity]] of base money ({{math|{{var|V}}{{sub|{{var|B}}}})}}, price level ({{mvar|P}}) and real output ({{mvar|Y}}) are related by definition: {{math|{{var|M}}{{sub|{{var|B}}}}{{mvar|V}}{{sub|{{var|B}}}} {{=}} {{var|P}}{{var|Y}}}}.<ref>{{cite book|title=Money Mischief: Episodes in Monetary History|last=Friedman|first=Milton|year=1994|publisher=Houghton Mifflin Harcourt|isbn=9780547542225 |pages=38}}</ref> However, the monetary base is a much narrower definition of money than [[M2 (economics)|M2 money supply]]. Additionally, the velocity of the monetary base is interest-rate sensitive, the highest velocity being at the highest interest rates.<ref name="Hussman2010"/>

In the early history of the United States, there was no national currency and an insufficient supply of coinage.<ref name=" David Ginsburg">{{cite book|url=https://books.google.com/books?id=nFkJTM2Rzc0C&q=how+gold+coins+circulated+in+nineteenth+century+america+ginsberg&pg=PA25|title=Gold Coins of the New Orleans Mint: How Gold Coins Circulated in 19th Century America|first= David|last= Ginsburg|year=2006| pages=25–33|publisher=Zyrus Press |isbn=9780974237169}}</ref> Banknotes were the majority of the money in circulation. During [[financial crises]], many banks failed and their notes became worthless. Also, banknotes were discounted relative to gold and silver, the discount depended on the financial strength of the bank.<ref name=" Taylor 1951"/>

In recent years changes in the money supply have historically taken a long time to show up in the price level, with a rule of thumb lag of at least 18 months. More recently Alan Greenspan cited the time lag as taking between 12 and 13 quarters.<ref>Greenspan interview on CNBC, 3 December 2010</ref>{{full citation needed|date=November 2022}} Bonds, equities and commodities have been suggested as reservoirs for buffering changes in the money supply.<ref>{{cite book|title=You Can Profit from a Monetary Crisis|last=Browne|first=Harry|year=1981|publisher=Ishi Press International |isbn=4-87187-322-6 }}</ref>

===Credit deflation===
In modern credit-based economies, deflation may be caused by the central bank ''initiating'' higher interest rates (i.e., to "control" inflation), thereby possibly popping an asset [[bubble (economics)|bubble]]. In a credit-based economy, a slow-down or fall in lending leads to less money in circulation, with a further sharp fall in money supply as confidence reduces and velocity weakens, with a consequent sharp fall-off in demand for employment or goods. The fall in demand causes a fall in prices as a supply [[Overproduction|glut]] develops. This becomes a deflationary spiral when prices fall below the costs of financing production, or repaying debt levels incurred at the prior price level. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets that have fallen dramatically in value since their mortgage loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation. To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans ([[Economic history of Japan#Deflation from the 1990s to present|as in Japan]], and most recently America and Spain). This is often no more than a stop-gap measure, because they must then restrict credit, since they do not have money to lend, which further reduces demand, and so on.

====Historical examples of credit deflation====
In the early economic history of the United States, cycles of inflation and deflation correlated with capital flows between regions, with money being loaned from the financial center in the Northeast to the commodity producing regions of the (mid)-West and South. In a [[procyclical]] manner, prices of commodities rose when capital was flowing in, that is, when banks were willing to lend, and fell in the depression years of 1818 and 1839 when banks called in loans.<ref name="North1966">
{{cite book |title      = The Economic Growth of the United States 1790–1860
 |last       = North
 |first      = Douglas C.
 |year       = 1966
 |publisher  = W. W. Norton & Company
 |location   = New York, London
 |isbn       = 978-0-393-00346-8
 |url-access = registration
 |url        = https://archive.org/details/economicgrowthof00doug
}}
</ref> Also, there was no national paper currency at the time and there was a scarcity of coins. Most money circulated as banknotes, which typically sold at a discount according to distance from the issuing bank and the bank's perceived financial strength.

When banks failed their notes were redeemed for bank reserves, which often did not result in payment at [[par value]], and sometimes the notes became worthless. Notes of weak surviving banks traded at steep discounts.<ref name="David Ginsburg"/><ref name="Taylor 1951"/> During the Great Depression, people who owed money to a bank whose deposits had been frozen would sometimes buy bank books (deposits of other people at the bank) at a discount and use them to pay off their debt at par value.<ref>Benjamin Roth, ed. James Ledbetter and Daniel B. Roth, ''The Great Depression: A Diary''. Perseus Books, 2009, p. 36. "A market for buying bank 'passbooks' also cropped up in places like Youngstown. If you were desperate enough in 1931 for money to buy basic necessities, you could get 60 to 70 cents on the dollar for your passbooks' value. Local newspapers even printed the weekly rates for buying and selling these passbooks as they became a commodity; Roth pasted one such rate chart into his diary."</ref>

Deflation occurred periodically in the U.S. during the 19th century (the most important exception was during the Civil War). This deflation was at times caused by technological progress that created significant economic growth, but at other times it was triggered by [[Financial crisis#19th century|financial crises]] – notably the [[Panic of 1837]] which caused deflation through 1844, and the [[Panic of 1873]] which triggered the [[Long Depression]] that lasted until 1879.<ref name="Wells1890"/><ref name="Taylor 1951"/><ref name="North1966"/> These deflationary periods preceded the establishment of the U.S. [[Federal Reserve System]] and its active management of monetary matters. Episodes of deflation have been rare and brief since the Federal Reserve was created (a notable exception being the [[Great Depression]]) while U.S. economic progress has been unprecedented.

A financial crisis in England in 1818 caused banks to call in loans and curtail new lending, draining specie out of the U.S.{{citation needed|date=February 2021}} The Bank of the United States also reduced its lending. Prices for cotton and tobacco fell. The price of agricultural commodities also was pressured by a return of normal harvests following 1816, the ''[[year without a summer]]'', that caused large scale famine and high agricultural prices.<ref>{{Harvnb|Taylor|1951|pp=336}}</ref>

There were several causes of the deflation of the severe depression of 1839–1843, which included an oversupply of agricultural commodities (importantly cotton) as new cropland came into production following large federal land sales a few years earlier, banks requiring payment in gold or silver, the failure of several banks, default by several states on their bonds and British banks cutting back on specie flow to the U.S.<ref name="North1966"/><ref>{{cite web
 | last1 = Wallis
 | first1 = Hohn Joseph
 | last2 = National Bureau of Economic Research
 | title = The Depression of 1839 to 1843
 | url = http://www.startabank.com/history/200809_TheDepression/depression1839.pdf
 | access-date = 2011-12-17
 | archive-date = 2012-03-07
 | archive-url = https://web.archive.org/web/20120307144159/http://www.startabank.com/history/200809_TheDepression/depression1839.pdf
 | url-status = dead
 }}</ref>

This cycle has been traced out on a broad scale during the [[Great Depression]]. Partly because of overcapacity and market saturation and partly as a result of the [[Smoot–Hawley Tariff Act]], international trade contracted sharply, severely reducing demand for goods, thereby idling a great deal of capacity, and setting off a string of bank failures.<ref name="Beaudreau1996" /> A similar situation in Japan, beginning with the stock and real estate market collapse in the early 1990s, was arrested by the Japanese government preventing the collapse of most banks and taking over direct control of several in the worst condition.

===Scarcity of official money===
The United States had no national paper money until 1862 ([[Greenback (money)|greenbacks]] used to fund the Civil War), but these notes were discounted to gold until 1877. There was also a shortage of U.S. minted coins. Foreign coins, such as Mexican silver, were commonly used.<ref name="David Ginsburg"/> At times banknotes were as much as 80% of currency in circulation before the Civil War. In the financial crises of 1818–19 and 1837–1841, many banks failed, leaving their money to be redeemed below [[par value]] from reserves. Sometimes the notes became worthless, and the notes of weak surviving banks were heavily discounted.<ref name="Taylor 1951"/> The Jackson administration opened branch mints, which over time increased the supply of coins. Following the 1848 finding of gold in the [[Sierra Nevada (U.S.)|Sierra Nevada]], enough gold came to market to devalue gold relative to silver. To equalize the value of the two metals in coinage, the US mint slightly reduced the silver content of new coinage in 1853.<ref name="David Ginsburg"/>

When structural deflation appeared in the years following 1870, a common explanation given by various government inquiry committees was a scarcity of gold and silver, although they usually mentioned the changes in industry and trade we now call productivity. However, [[David Ames Wells|David A. Wells]] (1890) notes that the U.S. money supply during the period 1879-1889 actually rose 60%, the increase being in gold and silver, which rose against the percentage of national bank and legal tender notes. Furthermore, Wells argued that the deflation only lowered the cost of goods that benefited from recent improved methods of manufacturing and transportation. Goods produced by craftsmen did not decrease in price, nor did many services, and the cost of labor actually increased. Also, deflation did not occur in countries that did not have modern manufacturing, transportation and communications.<ref name="Wells1890">{{cite book
|title=Recent Economic Changes and Their Effect on Production and Distribution of Wealth and Well-Being of Society
|last=Wells
|first=David A.
|year=1890 |publisher= D. Appleton and Co.|location= New York|isbn= 0-543-72474-3 |url= https://archive.org/details/recenteconomicc01wellgoog
|chapter=Money supply |page=222}}</ref>

By the end of the 19th century, deflation ended and turned to mild inflation. [[William Stanley Jevons]] predicted rising gold supply would cause inflation decades before it actually did. [[Irving Fisher]] blamed the worldwide inflation of the pre-WWI years on rising gold supply.<ref>
{{cite book |title=The Cost of Living in America: A Political History of Economic Statistics, 1880–2000 |last=Stapleford |first= Thomas |year=2009|publisher=Cambridge University Press |pages=69–73}}
</ref>

In economies with an unstable currency, barter and other alternate currency arrangements such as [[dollarization]] are common, and therefore when the 'official' money becomes scarce (or unusually unreliable), commerce can still continue (e.g., most recently in [[Hyperinflation in Zimbabwe|Zimbabwe]]). Since in such economies the central government is often unable, even if it were willing, to adequately control the internal economy, there is no pressing need for individuals to acquire official currency except to pay for imported goods.

===Currency pegs and monetary unions===
If a country [[currency peg|pegs]] its currency to one of another country that features a higher [[productivity growth]] or a more favourable [[unit cost]] development, it must – to maintain its competitiveness – either become equally more productive or lower its [[factor prices]] (e.g., wages). Cutting factor prices fosters deflation. [[Monetary union]]s have a similar effect to currency pegs.