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Answer:
Dear
BuyandHolder,
Deflation
is all about price declines -- more specifically it
is a widespread decline in the price of goods and
services -- in other words, falling inflation.
The
quart of milk that costs 89 cents this week would
cost less within months.
What
deflation does
It
might seem that falling prices would be a good thing,
but the likelihood is that salaries would also drop.
Deflation
can have two negative affects.
1)
Instead of stimulating production and employment,
deflation can undermine both. During deflation, companies
find themselves unable to raise prices because there
is a greater supply of goods and services than demand.
(This is referred to as a lack of pricing power.)
In some cases, companies must cut prices in order
to sell their products. The result, lower company
revenues with management forced to cut wages or even
fire people. Although prices of goods at this point
are cheaper, people out of work or making less simply
don't have the money to buy them.
2)
When deflation takes place, even people who are employed
tend to put off buying big ticket items, waiting for
prices to drop even lower. This too reduces economic
activity.
David
Resler, chief economist at Nomura Securities International,
points out, "It becomes a self-fulfilling downward
spiral."
About
the Federal Reserve Board
On
Tuesday, the Federal Reserve officials voted to leave
interest rates unchanged. The short-term interest
rate, which affects all kinds of loans, including
mortgages, remains at 1.25%, the lowest in 41 years.
At
the time, the Fed also issued a statement that the
central bank had some concerns about deflation. The
Fed, it appears, thinks the chances of deflation are
minimal but with inflation extremely low, it is a
possibility.
The
Fed is obviously focused on the situation and is expected
to take whatever steps it thinks necessary to guard
against deflation. The next meeting of the Federal
Reserve Board takes place June 24-25.
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