Right, so you ” re having an economic recession / slowdown / slump or whichever way you want to call it. And when people are expecting a fall in wages or retrenchment, they aren’t gonna spend much. On the contrary, they had better save for the rainy days. As a result, consumer spending falls and when that happens, firms are going to suffer as revenue and profits decreases. They are hence left with no alternatives but to decrease wages or start laying off people. At the same time, they’d have to lower prices to cope with the low aggregate demand.
Hence, the low aggregate demand transfers to a fall in prices. As people expect futher deflation, they delay their purchases in anticipation that prices will fall even futher. This hits manufacturers even harder. The cycle repeats itself and is known as the deflationary spiral! There are also other causes to a deflationary trend.
One of which is an increase in aggregate supply that outpaces that of demand. This could be due to technological advancements or increase in productivity or efficiency. Hence, an overcapacity results and prices fall. One example is the cheap imports that are coming out from China.
Like inflation, deflation may also be imported. A country that is heavily reliant on imports like Singapore would be very prone to external inflation / deflation. So how do you break out of this mess? Well obviously, there must be an increase in aggregate demand. There are a few ways to do this. Firstly, the government can increase money supply and lower interest rates. This would encourage borrowing and discourage people from saving, thus increasing consumer spending.
The Term Paper on Aggregate Demand And Supply Models
The economy in the United States has been trying reestablish itself by creating an economic stability by deriving a plan to get unemployment down, encouraging consumers and producers to put back into the economy, and that the current fiscal policies are written to stabilize the economy. The United States economy is based on a balance of making money, spending money, investing money, and trading ...
There is, however, a limit to which interest rates can be lowered. The government can decrease taxes and perhaps CPF to increase personal disposable income, thus boosting consumer spending. By increasing government expenditure on infrastructure, education, health, etc, aggregate demand can be lifted too. Tweaking the exchange rate may help.
By depreciating the domestic currency, exports will become cheaper and hence, demand for which would increase, contributing to an inflationary effect. At the same time, imports would become more expensive and prices will rise. Then again, these stuff are highly theoretical. If only things were so simple.
