Theory question 107
Money and Inflation(a) What is deflation?
(b) Outline any three positive effects of deflation.
(c) Explain the ways by which inflation affects any three functions of money.
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(a) Deflation is a persistent fall in the general price level (a rise in the value of money).
(b) Any three: value of money rises; people on fixed incomes and creditors gain; savings increase in value, encouraging saving; exports become cheaper and more competitive; imports fall, improving the balance of payments; cost of living falls.
(c) Any three: medium of exchange – people lose confidence in money and may return to barter; store of value – money loses purchasing power, so people hold real assets instead; unit of account – prices keep changing, making money a poor measure of value; standard of deferred payment – creditors are repaid with money worth less, so lending is discouraged.
Inflation weakens money's functions because its value keeps falling.