Although declining asset prices do not pose the same sorts of problems generated by falling commodity prices or retail prices of final output, they do indicate that financial markets recognize that the outlook for private sector profits around the globe is not rosy. Not only do these falling stock markets reflect pessimism, but they are also likely to have a negative impact on consumer investment and business demand around the world. Higher stock prices make equity finance for investment cheaper and engender consumers' confidence by making them feel richer so that they spend more. Stagnant, or lower, stock prices will discourage investment and consumer spending. The Real Costs of Deflation W hile the Federal Reserve has focused almost exclusively on the dangers of inflation for most of the past two decades, most studies find these dangers are very low.
Deflation increases real interest rates and debt burdens.
And many debtors will be stuck with longer-term, fixed rates that will rise in real terms. Although the negative impact on debtors is partially offset by higher real returns to their creditors, this is true only so long as debtors are able to meet their contractual liabilities. As Wynne Godley of the Levy Institute has demonstrated, the U.S. private sector has been running record deficits and accumulating record debts. As the prices that U.S. firms can obtain in an era of deflation begin to fall, they will find it increasingly difficult to meet their obligations. Deflation also discourages investment, research and development, and technological advance because firms cannot be reasonably sure that their expenditures can ever be recovered in an environment in which prices are falling.