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Until the 1930s, it was commonly believed by economists that deflation would cure itself. As prices decreased, demand would naturally increase and the economic system would correct itself without outside intervention.
This view was challenged in the 1930s during the Great DepressionThe Great Depression was a global economic slump that began in the United States following Black Thursday, the Wall Street panic of October 1929. On October 24, 1929, share prices on Wall Street collapsed catastrophically, setting off a chain of bankruptc. Keynesian economistKeynesian economics or Keynesianism is an economic theory based on the ideas of John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest and Money published in 1936 in response to the Great Depression of the 1930s. In Keys argued that the economic system was not self correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending. With the rise of monetaristMonetarism is a set of views concerning the determination of national income and monetary economics. It focuses on the supply and demand for money being the primary means by which economic activity is regulated. Monetary theory focuses on money supply and ideas, the focus in fighting deflation was put on expanding demand by lowering interest rates. This view has received a tremendous setback in light of the failure of accomodative policies in both Japan and the US to spur general increases in wages and demand after stock market shocks in 1987 and 2000 respectively.
Examples of deflation include the Great DepressionThe Great Depression was a global economic slump that began in the United States following Black Thursday, the Wall Street panic of October 1929. On October 24, 1929, share prices on Wall Street collapsed catastrophically, setting off a chain of bankruptc and the economy of JapanJapan's industrialized, free-market economy is the second-largest in the world after the United States in terms of international purchasing power. Its economy is highly efficient and competitive in areas linked to international trade, but productivity is during the 1990sCenturies: 19th century 20th century 21st century Decades: 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s 2020s 2030s 2040s Years: Events and trends Computers, technology Explosive growth of the Internet; decrease in the cost of computers and other techn. During the 19th century the gold standard was in use and known gold stocks were growing less rapidly than production. As a result, gold became more expensive in terms of goods, that is, a drop in the price level. This phenomenon ended with the discovery of gold reserves in South Africa and Alaska.
During World War I the British Pound Sterling was removed from the gold standard. It subsequently resulted in inflation and a rise in the gold price (fall in the value of the pound). When the Pound was returned to the gold standard after the war it was done on the basis of the pre-war gold price (hence lifting the value of the Pound). This caused a period of deflation as consumer goods realigned with the new value of the pound.
Major deflations: There have been two significant periods of deflation in the United States. The first was after the Civil War. The second was between 1930-1933 when the rate of deflation was approximately 10 per cent/year. The first was deliberate policy in retiring paper money printed during the Civil War, the second was part of America's slide into the Great Depression, where banks failed and unemployment peaked at 25%.
The deflation of the Great Depression did not occur because output fell. It occurred because bankruptcies created an environment where monetary base (cash) was in frantic demand, and the Federal Reserve did not adequately accommodate that demand, so banks toppled one-by-one like dominos. From the standpoint of the exchange equation, the drop in monetary velocity (money changing hands, sometimes calculated as GDP / money supply or constituents of money supply, like cash) was so profound that deflation took hold despite more money (increasing money suppply or constituents of money supply) chasing fewer goods (falling GDP).
Minor deflations: Throughout the nation's history, inflation has approached zero and dipped below for a short time (negative inflation is deflation). This was very common in the late 1800s, and was seen in the 1920's periodically.
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