Deflation typically occurs when the inflation rate falls below zero, with the falling price levels for goods and services. Because of the COVID-19 pandemic, the annual interest rate in Canada has fallen below zero. This hasn’t happened since the financial crisis of 2008, and Canada last viewed a negative inflation rate in 2009. Deflation, was presumed to be the cause for the severity of the Great Depression in the 1930’s, as the economic disaster was viewed as just a regular economic downtown that deflation had exasperated, producing an “unprecedented period pf high unemployment and suppressed income. Some say that the falling money supply is responsible for falling price level and the severity of The Great Depression.
As a consumer, falling prices seems like a good thing. Technically this means your money has more value, thus leading to more wholesome income! Andrew was feeling distraught that he only got 2 chocolate bars for $3, but now because of the price drop, Andrew can get 3 chocolate bars for $2.67! Interesting, now those that weren’t as wealthy and forced to be frugal, can now enjoy their increase in wealth; thus, consuming more! This was one of the theories presented by economist Arthur Pigou, in the 1930’s he proposed that for this reason alone, the falling prices would arguably help restore the economy towards full employment. We see that the Government of Canada is taking similar measures, not to decrease the money supply and keep the Canadian economy somewhat greased. Injecting large amounts of money through various fiscal measures into the economy, and crossing his fingers; Trudeau hopes, that these measures can fight the devastating effects of deflationary pressures. Yet there are still massive problems facing large companies in the aviation sector, like Air Canada, whom still require more than what Trudeau’s government is currently offering. What if Air Canada really is too big to fail?
Of course, there are other economists who saw deflation as having potential destabilizing effects. There is a theory that describes when deflation is unexpected, dubbed the debt-deflation theory, poses that the relationship between creditors and debtors will have changed. If the prices fall, and their money is worth more (like above), then also is the value of your debt, think of landlords and tenants. The Canadian Emergency Commercial Rent Assistance Program (CECRAP) gives equal weight in assisting both debtor and creditor, holding constant certain effects on either candidate, for example “responsibility”. This should have a net zero impact, but only if they were as equal in their attributes. Imagine that you have a lazy landlord and a responsible tenant, or a responsible landlord and a lazy tenant, either way there’s going to be an inequality. Trudeau is probably just hoping that the landlord-tenant relationship is now forced to better communicate, or else neither of them gets paid. Have landlords enjoyed being profitable for so long that they don’t care to evict, or are they just sick of irresponsible tenants; rather, what if landlord by large are better off?
Intuitively, we may have a relationship where the debtors are now looking to spend less (if you recall, their debt is also worth more), and the creditors aren’t really going to spend anymore than they do typically, but are now in a position that they can. The only way I can see that Creditors are looking to spend more is that if they are looking toward expansion or improvement (more generally than specific creditors). Now does it seem like the deflation is a benefit to the economy? However, when we foresee the deflation, the contraction is more apparent.
When firms expect there to be deflation, they expect that loans and investments are going to benefit them less in the future; therefore, there is fewer business investment, fewer people are hired, the overall demand curve drops. At the same time, banks are reluctant to lend money, because of the high risk that firms go belly up, and things can get complex, with real interest rates rising, people are reluctant to spend, as we start to approach a deflationary spiral. At the micro- level, we can start to include things like consumer time-preferences, which is the amount of time a consumer will tend to hold out on purchasing products because they expect prices to fall in the future, in micro-economics, we are more concerned with consumer behaviour than macroeconomics. I hope that now you can see how a deflation can quickly bring wrath to an economy, inventories will start to accumulate as we saw in the dairy industry and in a lot of farmers (like the pictures of potato hills we saw circulating online). Luckily, the demand for food will always be there, like health care we need both to survive. Deflation isn’t well studied, in universities the primary focus is on inflation. This is not to say that deflations haven’t happened, and there isn’t any information on them, we just don’t study them much. Seeing how the CECRAP will play out, more so how the economy will react to these measures, will be something to look forward to better understand the different ways a policy can run into issues.