Deflation is a process opposite to inflation and occurs when inflation is negative. Deflation means that prices of goods and services are decreasing. Such situation when prices are decreasing is not very common in economy, but sometimes happens, especially during economical depression. Deflation is as well dangerous for the economy as the high inflation is.
The bad situation is when deflation comes together with record low interest rates because the central bank doesn’t have a lot of better tools to control it. The other bad thing about deflation is that if deflation keeps for a long term, debtors may get in trouble because the real value of currency is increasing and gets harder to repay debts. Most of the governments also are in debts, so such situation is unfavorable to them.
The easiest way to fight deflation is to increase the amount of money circulating in the economy. In deflation conditions bonds gets additional points compared to other investments, however, when deflation is a reality, bonds offers very low yields. The deflation isn’t as bad as stagflation.
Deflation affects investments in different ways. Stocks are resistant for both inflation and deflation, and deflation does not much of harm to this class of assets directly. Direct effect of deflation to bonds is even positive because deflation increases the real value of money (bonds and other fixed income investments too).
However, deflation does not signal anything good to investments under normal conditions, because of indirect effect to the markets. During deflation the growth of economy is probable to stop and it won’t bring any benefits for stocks. The interest rates in the market usually also are very low and yields of bonds does not guarantees any significant return on investment.
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