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How did expectations of deflation affect consumer spending during the Great Depression?
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Great Depression
Unemployed men standing in line outside a soup kitchen, Chicago.
During the Great Depression, expectations of deflation significantly curtailed consumer spending, creating a self-reinforcing economic downturn known as a deflationary spiral.12
As prices and the money supply fell, consumers and businesspeople began to anticipate that wages and prices would continue to decline in the future. This expectation influenced behavior in several critical ways:1
- Delayed Spending: Because people expected prices to be lower in the future, they held onto their money and postponed purchases, particularly of durable goods.12
- Reluctance to Borrow: Even though nominal interest rates were low, individuals were hesitant to take on debt. They feared that future wages and profits would be insufficient to cover their loan payments in a deflationary environment.13
- Economic Contraction: This widespread hesitancy to spend and invest led to reduced demand, which forced companies to lower prices further to attract customers. As revenues dropped, businesses were unable to maintain production levels, leading to layoffs and increased unemployment, which in turn further reduced consumer income and spending.123
Ultimately, this cycle of pessimism and reduced consumption deepened the severity of the Great Depression.12