Deflation and its Positive Effects
Deflation is both a negative and a positive thing. Some of the positive effects of deflation include the fact that it reduces the burden of private and private debt. It also enables banks to adjust and control the interest rates of a product to stabilize the economy of a country (Gillman and Mátyás, 2004). The central bank is supposed to keep the nominal interests rate above zero, therefore, creating a positive potential output of a country. Keeping the nominal rates above zero ensures that the country utilizes all of its resources in a useful way.
Decrease in Inflation Rates
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A decrease in inflation rates occurs because of reasons like shortage of money in the country. Shortage of cash happens when people and banks hold on to cash to wait for prices of oil to go down or to let the value of the money go up. Also, having excess oil on the market than what consumers require can cause a decrease in inflation rates (Gillman and Mátyás, 2004). Having excess oil on the market is an advantage to the consumer but a disadvantage to the producer and the competitors as they have to lower their prices for them to sell their products.
Affected Potential Output
Potential output is what a particular county’s economy can produce when all of its resources are put together. The resources range from labor, natural resources or raw materials, current technology, etc. A decrease in deflation affects the potential output of a country in various ways. First, it causes high levels of unemployment in a country. Companies tend to cut all costs when they realize that they are not making a profit. During deflation, the prices of products decreases and thus companies end up making little money. They also close some of their stores, warehouses, and workstations. The result is the fact that the company lets go of employees for it to be able to survive.
In as much as reduced prices seem great to the consumer at first, once companies start cutting costs by laying off employees, the employees are forced to spend less money, and that leads to less demand which then leads to more deflation. Deflation is however not the same for every kind of business. In the technology business, deflation occurs without hurting the economy of their products because the companies manage to reduce the cost of production and at the same time lower the prices of their products. Unlike the oil industry which experiences deflation and inflation at intervals, the technology industry has managed to cut the cost of their products and also reduce their prices in a way that is not associated with a decrease in demand of their products (Burdekin, Denzau, Keil, Sitthiyot, and Willett, 2004).
Gross Domestic Product (GDP)
Gross domestic product (GPD) reflects the value of services and goods produced by a country in a given year (Burdekinet et al., 2004). If a country experienced deflation in oil products, the GDP would give a negative value or a value that is less than what the oil company anticipated before negative inflation occurred.
References
Burdekin, R.C., Denzau, A.T., Keil, M.W., Sitthiyot, T. and Willett, T.D., 2004. When does inflation hurt economic growth? Different nonlinearities for different economies. Journal of Macroeconomics, 26(3), pp.519-532.
Gillman, M., Harris, M.N., and Mátyás, L., 2004. Inflation and growth: Explaining a negative effect. Empirical Economics, 29(1), pp.149-167.
