If you’re like most people, you’d be thrilled about bargains. Who doesn’t like saving money? Who wouldn’t get excited about steep discounts? Well, too much of a good thing can be a bad thing. When it comes to economic trends, continuous price cuts and price declines make for very bad news. Here are the four reasons why.
Reason #1: Consumers spend less when they feel prices are dropping
Consumers will hold off on purchasing decisions if they suspect that prices will continue to drop. They feel they can get more bang for their buck if they hold off a week, a month, or even a year. This decrease in consumption hurts the economy’s growth rate.
Reason #2: Companies hire and expand less if prices are dropping
When prices drop, companies don’t have much leeway regarding their profit margins. Their profit margins shrink. This cuts into how much money they can devote to hiring people or expanding operations.
Reason #3: Lower prices push companies to slash prices even more
Once prices drop, market share competition can get really fierce. As companies cut their prices to protect their market share, their competitors are pushed to cut their pricing as well. This might not do much good since consumers, used to the price cutting, will hold off on making purchases in anticipation of more price cuts. This can make companies unprofitable.
Reason #4: Debt loads don’t get slashed when prices drop
Sadly, even when the prices of goods are dropping, the loans consumers and businesses have don’t drop. They stay the same and their interest remain the same. This can lead to an impossible situation with businesses because they can’t increase prices to boost profits. Instead, they are forced to pay off loans with less and less revenue due to price wars. Not surprisingly, deflationary spirals lead to many companies going belly up.
Keep the reasons above in mind the next time you read or hear about deflationary pressures. One thing is clear: deflation is bad news.