Typically, deflation is a sign of a weakening economy. Prices fall due to less consumer demand. In turn, this leads to an increase in unemployment numbers. Deflation can also tip an economy into recession. The ratio of public debt to GDP increases as the government is forced to increase spending on social welfare programs.

Japan is a textbook case of deflation. The Asian country’s economy has been wracked by deflation for the last 20 years. Economic and population growth has stalled.

But, economists are beginning to revise their opinion about the ill effects of deflation. Switzerland has proved to be an exception. Consumer prices have been going down in Switzerland for the last four years. And, the economy is doing just fine. Earlier this year, Switzerland’s central bank mandated negative interest rates for certain investments to stem an investor tide into the Swiss Franc from a rapidly devaluing Euro. In the aftermath of the introduction of the negative interest rate, economists expected the Swiss economy to go into a recessionary tailspin.

 

But, that has not happened. In fact, there has been a net increase in spending power, when wage gains are compared to the fall in prices. Switzerland’s achievement is even more remarkable, when you compare and contrast it with that of its neighbours in Europe. For example, Sweden’s economy, which witnessed a slide into deflation for much of last year, is on the cusp of a housing bubble.

All of this leads to the more general question of whether Switzerland is a one-off case or whether deflation occurs independent of other economic indicators. For example, an NBER paper distinguishes between good and bad deflation. According to the paper, good deflation occurs when aggregate supply outstrips aggregate demand, due to advances in technology or improved productivity.


Bad deflation occurs when aggregate demand falls faster than supply. The researchers cite Japan and the Great Depression of the 1930s as examples of bad deflation. The Swiss case seems to be an example of the Former
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For example, an NBER paper distinguishes between good and bad deflation. According to the paper, good deflation occurs when aggregate supply outstrips aggregate demand, due to
advances in technology or improved productivity.

So, the bottom line is Deflation has gotten a bad rap in recent times. However, as economic research and the Swiss Economy example shows that view may not be true in all cases.