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JonathanRanstrand
JonathanRanstrand
Deflation in Spain
May 18 2009, 2:34 PM EDT | Post edited: May 19 2009, 3:02 AM EDT
Today we were speaking about the risks associated with a fall in price levels (and the ensuing deflation) due either to a decrease in aggregate demand or an increase in short-run aggregate supply. Take a look at the following article from the New York Times;
http://www.nytimes.com/2009/04/21/business/global/21deflate.html

Retailers and other firms (including restaurants, supermarkets, etc.) in Spain are cutting retail prices to boost demand for their products. Obviously these falling price levels are a result of the global financial crisis; particularly, a decline in consumer and business expectations has led to a sizeable decline in aggregate demand. At the new macroeconomic equilibrium, we have lower price levels at a lower level of output. Because of the new lower level of output, unemployment is on the rise. As the article states, the unemployment rate is already a relatively large 15.5% and is increasing. In the short run, employers will be able to lower their prices and increase the quantity demanded for their goods, but this is by no means a long-term solution.

What do you think the Spanish government can do to prevent the economy from getting caught in this downward spiral? The article also mentions other nations reporting similar phenomena, with price levels falling; do you think this deflation will spread to other parts of Europe as well? Do you find this valuable?    
alexsvensson
alexsvensson
1. RE: Deflation in Spain
May 19 2009, 3:11 AM EDT | Post edited: May 19 2009, 3:11 AM EDT
The problem is essentially the lack of Aggregate Demand, as it leads both to falling prices and an increase in unemployment. Looking at the Spanish government, we could expect them to use either monetary or fiscal policy to solve the problem. Perhaps they will subsidize retailers, fiscal policy, although this is fairly unlikely. More likely, they can use monetary policy to change interest rates. When interest rates decrease it is no longer as beneficial for people to deposit their money in banks, and so spending and consumption is encouraged. There is evidence of this method all over the world, as interest rates are very low at the moment. So, to your final point, I believe that this might spread to other nations, but reactions to this might be very different depending on the nation we are looking at.
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