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Assess the impact on UK macroeconomic performance of a prolonged period of deflation.

Deflation means a fall in the price level; it is a negative rate of inflation. Currently, the MPC target an inflation rate of CPI 2% +/-1

If deflation is caused by a fall in aggregate demand or sluggish growth, then there could be several economic problems. Firstly, when prices are falling, consumers tend to delay spending, especially big purchases; this is because they expect goods to be cheaper in the future. This delay in spending can cause lower aggregate demand and lower economic growth. The MPC target an inflation rate of 2% because moderate inflation helps encourage a reasonable level of spending.
Another problem of deflation is that it increases the real value of debt. Firms and consumers with high debt will find it more difficult to pay off debt; debt interest payments will take a higher % of their disposable income. This can be a significant drain on spending and investment leading to lower growth. This might also be a particular problem in the UK, because of the relatively high rates of personal and business debt. In addition, deflation will make it more difficult for the government to reduce its debt/GDP ratio. Though, at least bonds should appear more attractive in a period of deflation.
Another potential problem of deflation is that it makes it harder for nominal wages to adjust and avoid real wage unemployment. Trade unions resist nominal wage cuts so
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with falling prices, we tend to get rising real wages, and this can cause real wage unemployment. An inflation target of 2%, helps real wages to adjust more easily.
Deflation is likely to make conventional monetary policy ineffective. Interest rates cannot fall below zero, therefore if we have deflation, real interest rates (nominal inflation) are likely to be too high for that stage

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