During periods of deflation, consumers decrease spending because they anticipate prices to drop and expect to buy goods and services cheaper. Also, firms lose confidence in the economy and reduce levels of investment causing aggregate demand to decrease and prices to fall. De Long and Summers, 1986 argue that “while a lower price level is expansionary, the expectation of falling prices is contractionary” (Davis, J., 2015, The asymmetric effects of deflation on consumption spending).
Additionally, deflation increases the real value of money hence consumers and firms have to pay more in real terms to repay their debts. Moreover, real wages increase causes unemployment to rise. The unemployed use their savings to buy necessities and fail to…show more content… Technological advances in computers during 1980 increased standards of leaving worldwide. Also, deflation can increase international competitiveness and improves the balance of payments if other countries have inflation. “During Japan’s deflation, the country saw strong exports which, helped offset the fall in consumer spending” (Problems of Deflation, Economics…show more content… With deflationary fiscal policy, the government increases taxes and reduces government spending. Hence, disposable income, consumption and investment are adversely affected and aggregate demand and prices fall. On the contrary, with expansionary fiscal policy, the government decreases taxes and increases government spending to increase aggregate demand. However, as the government borrows from the private sector to finance government spending, funds available for private investment decrease, affecting negatively investment levels (crowding out). Also, interest rates increase to make government bonds more attractive thus cost of borrowing increases. Consequently, the effect on aggregate demand from increased government spending might be wiped out from the decrease in private