What is the danger of deflation, and why do central banks try to avoid it?
Answer (1)
Deflation, which is the general decrease in prices over time, may sound like a good thing because it means cheaper goods. However, deflation is actually very dangerous for the economy and central banks like the Bangko Sentral ng Pilipinas (BSP) work hard to avoid it.One big problem with deflation is that people delay spending. If prices are falling every month, consumers think, “I’ll wait to buy this TV, phone, or new clothes because it will be cheaper next month.” This seems logical for individuals, but if everyone starts waiting, businesses earn less, reduce production, and eventually lay off workers. This leads to unemployment and a slower economy.Let’s take a Philippine example. Imagine cellphone prices are falling every month. Stores like those in Greenhills or SM malls start losing customers. They reduce workers' hours or close branches. Those workers lose income and stop spending as well, creating a cycle of low demand and more layoffs.Even worse, businesses stop investing. Why build a new factory or hire more people if you can’t sell your products at a profit? When business confidence drops, investment and innovation also decline. Deflation can even increase the burden of debt. If prices and incomes are going down, it becomes harder to pay back loans taken during better times.Central banks have limited tools to fight deflation. They usually lower interest rates to encourage borrowing and spending, but if rates are already near zero, there’s not much more they can do. This is called a liquidity trap.Japan suffered from long-term deflation in the 1990s and early 2000s. Despite being a rich country, growth was very weak, and young people had a hard time finding jobs. This is why central banks around the world prefer mild inflation of around 2% instead of deflation. It keeps the economy moving and encourages healthy spending and investment.
