Question: What Is Deflation?
Answer: When prices generally continue to fall. This may seem like a great thing, except that the cause for deflation is a long-term drop in demand. Unfortunately, a drop in demand means that a recession is already underway, with job losses, declining wages, and an ongoing decline in the value of your home. Deflation is a result of businesses dropping prices in a desperate attempt to get people to buy their products.
Deflation is measured by a decrease in the Consumer Price Index. To offset it, the Federal Reserve must instill an expansionary monetary policy. It must reduce interest rates, and increase the money supply in an attempt to jump-start economic growth. In addition, the government can offset deflation with expansionary fiscal policy. It can put more money into circulation by lowering taxes, increasing government spending, and incurring a temporary deficit to do so. Of course, if the deficit is already at record levels, that tool may no longer be available.
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