As you remembered Inflation for higher prices, deflation is just quite opposite which characterized by lower prices. It is a macroeconomic condition where a country experiences lowering prices. According to many economists, deflation is a more serious issue than inflation and requires extra care in order to deal with it. Since deflation is very difficult to control, so what’s important than understanding the definition of it, is to understand, “how it affects investors?”
Deflation occurs when the change in prices turns negative. And when that happens, most things get cheaper, even though it seems like a wonderful thing to not to pay big amount but if it keeps going for too long, companies’ profits begin to diminish. It is common-thinking that decrease in the price of goods is beneficial from a consumers point of view. But, only certain goods like food or energy.
But, the truth is, a sudden drop in the prices can have severe negative impacts on investors, growth, and economic stability. In such economic conditions, it forces companies to sell their products/services for even cheaper prices and cut their production in low demand. Also, deflation is the cause of the recession; reduce employee wages and closing of production facilities. At this moment, the economy cannot expand since unemployment increase with deflation and people aren’t spending their money because of future uncertainty.
The equity market is also the one most affected by it. In the situation of deflation, the equity prices begin to decline and investors sell off their investments which are no longer giving good market returns. During this time, the government bonds become more attractive to have in the portfolio. Until the government finds a solution, the equity prices will be negatively impacted.
Final Thoughts: –
As you can see, the effects of deflation are much worse than the inflation. At least, in inflation, the government can reduce spending and encourage saving by increasing interest rates however as the government does the opposite to encourage spending during deflation. In deflation, the government can’t just lower the nominal interest rates to a negative level or below zero.
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