Analysis of Economic Deflation

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Case Study Paper
For years, inflation has been the primary economic threat. However, the successes in fighting inflation and global economic forces have combined to unleash a new possible threat: deflation. Deflation, which has caused currency devaluation abroad, is a significant cause of the market's current volatility. It could lead to a recession in the United States, but its existence is sporadic, having occurred in more than six decades. While the US has had brief periods of deflation in the past century, it has not experienced a long-term deflation since the great depression in the 1930s (Davidson, 2020). The period was accompanied by a massive drop in prices that put many firms out of business and their employees out of work. This paper analyses deflation, selected from the Washington Post dated September 16, 2021.
Economically, deflation is an actual decline in the prices of goods and services. Various factors, including a decrease in consumer demands for goods and services, a drop in the money supply or an increase in the supply of goods, and the emergence of new technology that lets manufacturers produce additional products at lower prices cause deflation. Simply put, the causes of deflation go back to demand and supply. Deflation occurs when the demand for goods and services declines and supply increases, as explained in the graph below.
Figure 1: The Deflation Graph (Intelligenteconomis.com, 2021)
Figure 1 shows a shift to the left in the Aggregate Demand (AD) lowers P1 to P2 and output from Y1 to Y2 (Intelligenteconomist.com, 2021). A decrease in AD can occur due to a financial crisis or a fall in import consumption of trade partners. This leads to a new equilibrium at a decreased price level P2 and a real GDP of Y2 (Intelligenteconomist.com, 2021).
There are numerous reasons to fear deflation. Firstly, it decreases business revenues. Since prices are forced down, the profits made by businesses reduce. Companies respond to the decreasing revenues by slowing down their production, leading to layoffs and salary cuts (Harding et al., 2021). A reduction in wages and a rise in unemployment changes consumer spending, which harms the economy further. Therefore, deflation periods often result in reduced economic growth and lower consumer spending.
Secondly, deflation reduces equity prices as consumers sell off their investments. Many economists consider deflation worse than inflation because it is difficult to control. At its worst, deflation can turn into a deflationary spiral, weakening a nation's currency (Qidi, 2017). As consumption and investment spending declines, aggregate demand falls, and this causes prices to reduce even further. The outcome is more deflation due to more consumption and spending cuts and further price reduction (Davidson, 2020). Consequently, the economy crashes, resulting in the so-called 'debt-deflation spiral.'
Thirdly, deflation increases debt value, reducing the ability of debtors to settle their debts. During deflation, interest rates may...