QE will last until 2022, and now the world will accept that QE is no more.
Many beginners in economics have a question, that is, why do we sometimes worry about inflation, and why do we sometimes worry about deflation? And, why does the Fed need to raise interest rates again to curb runaway inflation? What should the Fed do next?
The simplest way to understand inflation and deflation can be understood as the relationship between human body temperature and fever. We need a certain body temperature to maintain the body's operation, and the human body's temperature cannot be too high or too low. Fever occurs when inflation (body temperature) is too high. Fever also occurs when inflation (body temperature) is too low.
The responsibility of the central bank is to control the economy as an organism, and the temperature should neither be too high nor too low. Because whether it is too high or too low, it will cause serious economic imbalance, soaring unemployment rate, or soaring prices, which will eventually lead to economic or financial crises of varying degrees.
Of course, the above examples are examples for readers to understand more intuitively what inflation is, and the relationship between inflation and deflation.
Academically defined:
Inflation and deflation are two concepts in economics that describe changes in the price level.
Inflation refers to the increase in the overall price level, the decrease in the purchasing power of money, and the fact that people pay more for the same amount of goods and services with the same money. Inflation is usually caused by factors such as an increase in the money supply, demand exceeding supply, or rising production costs. Conversely, deflation refers to a fall in the overall price level, an increase in the purchasing power of money, and people paying less for the same amount of goods and services with the same money. Deflation is usually caused by factors such as a reduction in the money supply, a lack of demand, or a fall in the cost of production.
There is an interactive relationship between inflation and deflation. In general, inflation and deflation are caused by changes in money supply and demand. Inflation can occur when the supply of money increases and demand exceeds supply. And when the money supply is reduced and demand is insufficient, deflation can occur. Therefore, inflation and deflation can be transformed into each other, and there may be cyclical fluctuations in the economy.
The above figure can well illustrate the relationship between inflation-stagflation and deflation in the roller coaster of economics. Inflation is an upward process, stagflation is a cycle of ups and downs, and deflation is a state where the car suddenly falls to the bottom.
The impact of deflation on the economy can be huge. The main reasons include the following:
Debt Problems: Deflation makes borrowing more expensive because debtors need more money to pay back their debts. This can cause businesses and individuals to be unable to service their debts, exacerbating the risk of a recession.
Reduced consumption and investment: Deflation causes people to expect further declines in prices, so they may delay consumption and investment. This reduction in consumption and investment further weakens economic growth.
Falling wages: Deflation is usually accompanied by rising unemployment, as businesses may lay off workers to reduce costs. At the same time, deflation can also exert downward pressure on wage levels, leading to a reduction in real income for workers.
Increased debt burden: In deflationary times, the real value of debt increases because the purchasing power of money increases. This is a problem for individuals, businesses, and governments as they need more money to service their debts, adding to their debt burdens.
A concrete example is Japan's lost twenty years. In the early 1990s, Japan experienced a deflationary phase after the bubble economy burst.
During Japan's lost two decades, deflation hit the economy massively:
Long-term economic stagnation: Deflation has led to long-term economic stagnation, and Japan's GDP growth rate continues to be depressed. Businesses and individuals expect prices to continue to fall, causing them to delay consumption and investment, further dampening economic growth.
High Unemployment: During deflation, Japan's unemployment rate rises. Many companies have cut jobs to cut costs amid falling corporate profits and weak demand. High unemployment leads to a reduction in people's income and spending power, further depressing economic activity.
Vicious deflationary cycle: During deflation, consumers expect prices to fall and prefer to hold cash rather than spend. This leads to lower demand, lower business sales and lower profits, further weakening the willingness of businesses to invest and hire. This vicious circle makes the deflation problem worse and is very difficult to break.
Increased debt problems: Deflation increases debt burdens, especially for individuals and businesses. Rising real debt burdens have led to more defaults and bankruptcies, further shocking the financial system and economic stability.
Overall, the shock to the economy from deflation is huge, weakening consumption, investment and employment, and increasing the debt burden. It also leads to economic stagnation and a vicious cycle that makes it difficult to restore economic growth. As a result, policymakers typically take steps to avoid deflation and stimulate demand through monetary and fiscal policy in order to maintain steady economic growth.
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