Deflation gap - it is a situation in which the sum of expenses (this is about spending on goods and services produced in the country) is lower than the national income (inflows lower than outflows) at the national income ensuring full employment. If the national income at the equilibrium point (Ye) is below the full employment level (Yf), there will be an under-utilization of the production capacity in the economy, and thus unemployment will emerge due to a shortage of demand. This phenomenon is called deflationary gap.
The size of the deflation gap is shown by the section a - b, i.e. the distance between line 45 and line E at the national income providing full employment (Yf). It is also the size, c - d, i.e. the size by which the outflows exceed the inlets. If the national income is to be increased from Ye to Yf, the inflows must be increased and / or outflows reduced to eliminate the deflation gap. Note that the size of the deflation gap is less than the difference between Ye and Yf. This is another example of a multiplier. If the inflows are increased, oa - b (and thus ocd), the national income will increase by Yf - Ye. The multiplier therefore has the form:
What is deflation?
Deflation is the general decline in prices for goods and services occurring when the inflation rate falls below 0%. Deflation happens naturally when the money supply of an economy is fixed. In times of deflation, the purchasing power of currency and wages are higher than they otherwise would have been. This is distinct from but similar to price deflation, which is a general decrease in the price level.
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- Kaufmann, D. (2017). Is Deflation Costly After All? The Perils of Erroneous Historical Classifications (No. 17-09). IRENE Institute of Economic Research.
- Kaufmann, D. (2016). Is Deflation Costly After All? Evidence from Noisy Historical Data. KOF Working Papers, 421.