Deflation is what follows recession on the downward slope to depression.But is it a bad thing?The answers are both yes and no, but you have to understand what deflation is.
Deflation occurs when prices begin to fall.This isn't a fire sale kind of price reduction but one that occurs at the manufacturing level.This is a good thing right?It can be particularly if goods being produced were overpriced.What happens is that profit margins shrink.That can be okay but there is an elastic limit as to how much contraction can occur before operations are impacted.The other side of the coin is that the retailer is also forced to reduce prices on already paid for inventory.Again the same principles apply.Elastic limits.If they are pressured to this point inventory doesn’t sell.That is where meeting expenses becomes a problem and business collapse a reality.
Back to our producers.They too will eventually have to scale back operations and that means reducing operations costs beginning with benefits packages then job losses.None of this is new because it all happens in a recession as well.Governments usually try to combat this by reducing interest rates in order to spur lending and put the economy on a recovery road.Their other tool is to initiate infrastructure spending however the danger in this is having the money to afford it.If the country has no reserve or contingency funds it has to borrow in order to finance the projects.The problem here is that with low interest rates the return on the bonds is low so investors are shy.The governments are then forced into deficit spending.
So an already slow economy in recession slips further as the Producer Price Index falls with interest rates, productive output (GDP and trade balances) and corresponding increases in unemployment and both personal and business bankruptcy.
Now to the consumer.The personal finance of the consumer can well determine whether money will be made or lost in this type of economy.If the consumer has equity and liquidity (ownership and cash) then buying into bonds etc can be a good thing even with low yields.Over time, their values will increase as economic recovery becomes a reality.That is good for someone with patience.Investment in this type of economy does require a great deal of patience.
If the consumer is debt ridden then there becomes a point in falling prices where the equity and the value of the property are equal and if the property values continue to decline then turning in the keys and declaring bankruptcy is a better move financially.Why pay for something that will sell for less than your equity value?(This is a problem with the US subprime markets although it is a different situation.The analogy is the same.)
So if a deflationary economy is short lived it can be an opportunity because it is likely to be more of an economic adjustment than a sign of worse things to come.If it is protracted then depression is the bottom of the ladder.That is possible but unlikely without a worldwide banking collapse.