Deflation: What Is It and What Does It Mean for Investors?

Question 1 

Deflation describes a fall in the normal price level or negative inflation. Since 1990, Japan experienced more than two decades of deflation (Misawa, 2013). There are two main forces that could potentially cause inflation: 

A reduction of aggregate demand (AD). 

Lower costs of production or the aggregate supply (AS) shifting to the right. 

Figure 1 showing the causes of deflation ( Pettinger, 2018). 

Deflation often occurs during a severe recession due to the continuous fall in output and demand. It may also occur because of a severe tightening of a country’s monetary policy or after a credit boom and bust phase ( Pettinger, 2018) . Technological advancement may reduce the cost of production and cause deflation. Further, a rapid fall of oil prices can cause deflation. 

The US has experienced deflation in recent times, but it was not as severe as predicted. The country experienced deflation in January 2015 when the prices of good reduced by about 0.1%, but the prices increased from February ( Gillespie, 2018) . The January deflation was caused by the rapid decline in oil prices. The price of gas had fallen to almost $2.15 on average from about $3.40 in 2014 ( Gillespie, 2018) . The other time the US experienced deflation was during the financial crisis of 2007 -2010 ( Gillespie, 2018) . However, it only lasted a few months. The recession was caused by the liquidity that affected the US banking sector. 

Question 2 

Japan can overcome deflation by spurring consumption of goods in the economy. the country should embark on a major government bond purchasing program. By 2015, the Japanese government bonds were worth about $1.8 trillion, an amount that was almost the size of Canada’s economy ( Mukherjee, 2018) . The bond-buying program is essential in spurring consumption and ending deflation. If the government buys more bonds, it may force prices of goods in the economy to start rising. 

Due to deflation, most people in Japan store money instead of spending it (Misawa, 2013). Therefore, increasing the money supply in Japan's economy may increase consumer spending. If money supply in Japan's economy increases while the supply of services and goods remain constant, it is highly likely that prices will increase ( Kuroda, 2013) . If the Bank of Japan purchases more government bonds, financial institutions will have more resources at hand. Financial institutions play a critical role in the flow of money in an economy. Since financial institutions will have more cash, they offer more loans to corporates and individuals to spend on expanding businesses, hiring more employees, purchasing cars, and many other activities. By influencing a rise in demand forces, it may cause higher prices. Similar to Ina Food that increased the prices of its goods so that it could increase sales while improving profit margins, Japan has to buy more bonds so that it can influence people to spend more money in the economy (Misawa, 2013). 

Question 3 

If Tsukakoshi had decided to lower prices of goods and services, it would have had an adverse financial impact on the company. Consumers could have held back on spending or postpone their demand with an expectation that prices will continue falling (Misawa, 2013). Additionally, the company's real value of debts would have increased, and it would have negatively affected consumer confidence ( Mukherjee, 2018) . Moreover, it would have increased the real cost of loans. The real interest rates would have risen if the prevailing interest rates in Japan had not fallen similarly to commodity prices. 

Notably, it would have reduced the company’s profit margins. Reducing the prices of commodities would have affected the profit and revenue margins. Ultimately, the company would have sought to reduce its production costs by reducing recruitment or shedding labor. Since the business imported essential raw materials, it would have made them less competitive because they would be forced to pay more for imports regardless of the declining profit margins ( Pettinger, 2018) . Moreover, it would have negatively affected income distribution in the company. Income would have been redistributed from the company to their debtors. Ultimately, it would have affected Ina Food’s savings and confidence because the falling asset prices would have affected the company’s value and confidence of shareholders. 

References 

Gillespie, P. (2018). America has deflation in January. Retrieved from https://money.cnn.com/2015/02/26/news/economy/inflation-January-negative/index.html 

Kuroda, H. (2013). Overcoming Deflation and After. Retrieved from https://www.boj.or.jp/en/announcements/press/koen_2013/data/ko131225a1.pdf 

Misawa, M. (2013). Ina Food Industry (2). Marketing Strategies in a Deflationary Environment. Asia Case Research Center. 

Mukherjee, A. (2018). How to end Japan's deflation? Abolish cash. Retrieved from https://economictimes.indiatimes.com/markets/stocks/news/how-to-end-japans-deflation-abolish-cash/articleshow/65277623.cms 

Pettinger, T. (2018). Causes of Deflation. Retrieved from https://www.economicshelp.org/blog/8968/uncategorized/cause-deflation/ 

Pettinger, T. (2018). Problems of Deflation. Retrieved from https://www.economicshelp.org/blog/978/economics/definition-of-deflation/