Deflationary spiral | Inflation | Finance & Capital Markets | Khan Academy

ruticker 08.03.2025 21:05:04

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So, in a normal economy, we know that **employment** will drive overall **demand**. If we have high employment or low unemployment, then people are going to have more jobs, and they're going to have higher wages, which will lead to higher demand. Conversely, if the situation reverses and people lose their jobs, demand will go down, wages will start to decline, and people won't have money in their pockets. Thus, employment drives demand. We can view demand—though I'm making a huge simplification here—as driving **production** or, perhaps, we could think of it as **supply**. It will also drive prices. Of course, there is a little bit of a negative feedback loop for both of these things. If demand is high and prices go high, that might produce a little bit of negative feedback on demand. This type of line here means negative feedback, or I'll put a little negative sign here. Let's say the demand is high, and then the supply goes high. Well, that might also make the demand—actually, the supply going high would drive the price down. So maybe I should draw a negative feedback line here: high supply would mean lower prices. But that's not what I want to focus on in this video. We could keep adding more lines here, but this is a roughly simple take on it. The general idea is that **supply** and **price** will then drive **corporate profits** or just profits in general, even for an individual business owner. Then, profits are going to drive employment. Now, let's imagine a scenario where we are in a bad economy, maybe a depression-like economy. In that situation, you can start really at any point in the circle. I'll just start with employment. So, let's say employment is really low. That's going to make demand really low, and if demand is really low, then supply is going to go down, and prices are going to go down. Then, that's going to make profits go down, which will, in turn, make employment even lower. So, we find ourselves in this kind of recessionary or depressionary environment. This would be called a **deflationary spiral**. It's a spiral because a bad economy is driving lower prices, which is in turn driving a bad economy. To make matters worse, if this continues long enough or if these price declines are severe enough, you could imagine people saying, "Look, I have this dollar in my pocket. I'm not going to spend this dollar because, one, I might lose my job at any moment, and I know that that dollar is becoming more powerful; I can buy more every minute that I wait." As prices go down and all of the scary stuff happens—employment is going down, profits are going down, prices are going down—this makes people hoard money instead of goods. This is different from an inflationary spiral, where people hoard goods. It makes them hoard money. Why is this ultra scary for central bankers or for governments? Because they start to not have as much control over the economy. They can't just run the printing press and try to stimulate the economy in this situation. If they did, people are so conservative right now. You can imagine maybe a depression going on for years. Let's say they take some type of helicopter—this isn't how you actually distribute money into the money supply, but it's just to show an extreme example. So, they take a helicopter and start dumping cash on people. They print cash and start dumping it on people, so every man, woman, and child in the country gets a ten-dollar bill. Well, if people are really scared and really afraid, they're just going to take that ten-dollar bill and stuff it into their mattress. It's not going to change anything; that dollar isn't going to actually enter into the money supply. The velocity on it will be zero.

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