As much as I appreciate your point in question 3, I must stress that even if the deflation is not anticipated, it will probably still occur. The fact that people expected the inflation to continue rising in the USA, they still got into a recession and it surprised the people which actually worsened its effect.

2. This is because consumers will not spend in order to spend later when prices are lower. By anticipating the deflation, the consumers are only speeding its arrival and aggravating the problem.

3. This article does not really present valid evidence that the deflation will eventually self-correct and it actually seems to predict that doom will occur if this problem continues

4. These policies are being used because these governments remember that it was only due to government intervention that they pulled themselves out of the Great Depression. Based on that experience, the best course of action is reflationary policy.

With falling prices borrowers will experience an increase in the real value of their debt and in such a climate, companies and individuals with debt may struggle. This in itself may exert a further twist to the downward deflationary spiral. Also, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.
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2) The expectation of future deflation can have an equally devastating effect. Why is this?

Deflation may cause people to postpone their spending in the expectation of even lower prices in the future. When this happens, aggregate demand falls, businesses are unable to sell their goods, make profits or meet their debt repayment obligations, and they may be forced to cut output and employment of workers.
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3) What evidence does the article put forth that an economy experiencing deflation may eventually “self-correct”, meaning return to the full employment level of output in the long-run?

Deflation persisting in the economy depends on the mindset of the public. “So far, expectations of inflation remain stable: that sentiment is itself a welcome bulwark against deflation.”
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4) Why don’t governments and central banks just sit back and let the economy self-correct? In other words, why are fiscal and monetary policies being used so aggressively by the US, Great Britain and Switzerland during this economic crisis?

Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. “…inflation is easier to put right than deflation. A central bank can raise interest rates as high as it wants to suppress inflation, but it cannot cut nominal rates below zero… In the worst case, rising debts and defaults depress growth, poisoning the economy by deepening deflation and pressing real interest rates higher… Given the choice, erring on the side of inflation would be less catastrophic than erring on the side of deflation.”

With your answer to number 4, I think its important to further examine the situation before concluding that the economy cannot self-correct. Even if consumer prices are falling due to a decrease in aggregate demand and consumer spending, there is still a chance that the economy can self-correct.

2) If deflation is expected in the near future then consumers who would normally consume would rather save their money for the rainy day approaching, by doing this they are effectively doing the same as they will have in Question 1, which leads to the same downward spiral.

3) The article states that people will “cut spending” which will mean they will save more. Firms have access to this saving and therefore will this money to increase their stock of capital and their output, which will increase the national income again.

4) Governments don’t wait for the economy to self-correct because this would take a long time, this can only happen in the long run. The huge fiscal stimulus are implemented because people are not willing to accept lower wages at the time. The short run is also called the sticky wages period, meaning that firms cannot decrease wages in such a short time limit. For the economy to self-correct people would have to accept lower income and therefore less spending.

You mentioned how it is more beneficial for a government to adopt a Keynesian policy than a Neo-Classical policy because this will create a quicker recovery for the economy. However, it is important to remember that from a Neo-Classical point of view such a policy will only serve to support inflation in the future.

Deflation puts pressure on wages and prices. If this is caused due to a decrease in the aggregate demand, it will lead to a decrease in most working hours and an increase in unemployment as a whole. Also, the real value of debt burdens will increase, which will mean that borrowers will spend less money, which will further decrease aggregate demand.

2)The expectation of future deflation can have as equally devastating effect. Why is this?

With an expected rise in deflation, people will suppose that their disposable income will decrease dramatically. This belief will cause them to decrease their expenditure, in order to save their resources. In turn, this will decrease the aggregate demand, and the deflation will come to pass. In a way, the anticipation of deflation will lead to actual deflation.

3)What evidence does the article put forth that an economy experiencing deflation may eventually “self-correct”, meaning return to the full employment level of output in the long-run?

This is a Neo-Classical idea, and any Keynesian would disagree. Neo-Classical economists would state that the economy experiencing deflation could in the long run actually “self-correct” for three main reasons. First of all, with a decrease in consumer prices, the aggregate demand will increase, which will cause an increase in employment and thus income. Also, firms will save up their resources, and eventually they will increase their employment, which will increase the supply. This will increase the aggregate demand, and the economy will return to its former level. Lastly, banks are able to manipulate the unterest rates. With banks lowering the interest rates, people would be more willing to spend. This, in turn, will increase the aggregate demand. However, the Keynesians would argue that prices and wages will “stick” at a low level, and the full employment level of output will only be restored with a government intervention in the form of a reflationary policy.

4)Why don’t governments and central banks just sit back and let the economy self-correct? In other words, why are fiscal and monetary policies being used so aggressively by the US, Great Britain and Switzerland during this economic crisis?

In theory, the Neo-Classical method is perfectly reasonable, but in practice it has been proven to not be completely effective. Also, it is unlikely that a government simply has the time to sit and wait for the economy to self correct. Governments, especially those in the US, Great Britain, and Switzerland, need support from the majority of the population. In a situation of a serious recession or of rampant deflation, if the government were to just wait for the economy to self correct they would be replaced. In general, even if the Keynesian method isn’t necessarily sound, at least it does something!

On your first point: I think you hit a good point there that deflation can lead to unemployment, I just want to expand on why this happens: If deflation is caused by a decrease in aggregate demand, then companies are producing too much. They will therefore reduce production, for which they need less workers, hence unemployment rises.

Your second point: Nice! I had not thought of this before, but it is a good point that if people are expecting prices to fall, they may wait longer and longer, thinking that prices will decrease even further. If I was to buy a new car, then I would also wait longer and longer seeing as the price is reducing and I don’t have a huge amount of money to spend, i.e. I could spend it on other things. Well done!

Your third point: I didn’t quite understand why firms would eventally save money to hire more workers!? Why would they do so if they only need to produce less anyways?