Deadweight cost/loss
The extent to which the value and impact of a tax, tax relief or SUBSIDY is reduced because of its side-effects. For instance, increasing the amount of tax levied on workers’ pay will lead some workers to stop working or work less, so reducing the amount of extra tax to be collected. However, creating a tax relief or subsidy to encourage people to buy life insurance would have a deadweight cost because people who would have bought insurance anyway would benefit.
Deflation
Deflation is a persistent fall in the general price level of goods and SERVICES. It is not to be confused with a decline in prices in one economic sector or with a fall in the INFLATION rate (which is known as DISINFLATION).
Sometimes deflation can be harmless, perhaps even a good thing, if lower prices lift real INCOME and hence spending power.
Deflation is dangerous, however, more so even than inflation, when it reflects a sharp slump in DEMAND, excess CAPACITY and a shrinking MONEY SUPPLY, as in the Great DEPRESSION of the early 1930s. In the four years to 1933, American consumer prices fell by 25% and real GDP by 30%. Runaway deflation of this sort can be much more damaging than runaway inflation, because it creates a vicious spiral that is hard to escape. The expectation that prices will be lower tomorrow may encourage consumers to delay purchases, depressing demand and forcing FIRMS to cut prices by even more. Falling prices also inflate the real burden of DEBT (that is, increase real INTEREST rates) causing BANKRUPTCY and BANK failure. This makes deflation particularly dangerous for economies that have large amounts of corporate debt. Most serious of all, deflation can make MONETARY POLICY ineffective: nominal interest rates cannot be negative, so real rates can get stuck too high.
Demand curve
A graph showing the relationship between the price of a good and the amount of DEMAND for it at different PRICES.
Deposit insurance
Protection for your SAVINGS, in case your BANK goes Bust. Arrangements vary around the world, but in most countries deposit insurance is required by the GOVERNMENT and paid for by banks (and, ultimately, their customers), which contribute a small slice of their ASSETS to a central, usually government-run, insurance fund. If a bank defaults, this fund guarantees its customers’ deposits, at least up to a certain amount. By reassuring banks’ customers that their cash is protected, deposit insurance aims to prevent them from panicking and causing a bank run, and thereby reduces SYSTEMIC RISK. The United States introduced it in 1933, after a massive bank panic led to widespread BANKRUPTCY, deepening its DEPRESSION.
Depreciation
A fall in the value of an ASSET or a currency; the opposite of APPRECIATION.
Depression
A bad, depressingly prolonged RECESSION in economic activity. The textbook definition of a recession is two consecutive quarters of declining OUTPUT. A slump is where output falls by at least 10%; a depression is an even deeper and more prolonged slump.
The most famous example is the Great Depression of the 1930s. After growing strongly during the “roaring 20s”, the American economy (among others) went into prolonged recession. Output fell by 30%. UNEMPLOYMENT soared and stayed high: in 1939 the jobless rate was still 17% of the workforce. Roughly half of the 25,000 BANKS in the United States failed. An attempt to stimulate growth, the New Deal, was the most far-reaching example of active FISCAL POLICY then seen and greatly extended the role of the state in the American economy. However, the depression only ended with the onset of preparations to enter the second world war.
Why did the Great Depression happen? It is not entirely clear, but forget the popular explanation: that it all went wrong with the Wall Street stockmarket crash of October 1929; that the slump persisted because policymakers just sat there; and that it took the New Deal to put things right. As early as 1928 the Federal Reserve, worried about financial SPECULATION and inflated STOCK PRICES, began raising interest rates. In the spring of 1929, industrial production started to slow; the recession started in the summer, well before the stockmarket lost half of its value between October 24th and mid-November. Coming on top of a recession that had already begun, the crash set the scene for a severe contraction but not for the decade-long slump that ensued.
So why did a bad downturn keep getting worse, year after year, not just in the United States but also around the globe? In 1929 most of the world was on the GOLD STANDARD, which should have helped stabilise the American economy. As DEMAND in the United States slowed its IMPORTS fell, its BALANCE OF PAYMENTS moved further into surplus and gold should have flowed into the country, expanding the MONEY SUPPLY and boosting the economy. But the Fed, which was still worried about easy CREDIT and speculation, dampened the impact of this adjustment mechanism, and instead the money supply got tighter. Governments everywhere, hit by falling demand, tried to reduce imports through TARIFFS, causing international trade to collapse. Then American banks started to fail, and the Fed let them. As the crisis of confidence spread more banks failed, and as people rushed to turn bank deposits into cash the money supply collapsed.
Bad MONETARY POLICY was abetted by bad fiscal policy. Taxes were raised in 1932 to help balance the budget and restore confidence. The New Deal brought DEPOSIT INSURANCE and boosted GOVERNMENT spending, but it also piled taxes on business and sought to prevent excessive COMPETITION. Price controls were brought in, along with other anti-business regulations. None of this stopped – and indeed may well have contributed to – the economy falling into recession again in 1937–38, after a brief recovery starting in 1935.
Deregulation
The process of removing legal or quasi-legal restrictions on the amount of COMPETITION, the sorts of business done, or the PRICES charged within a particular industry. During the last two decades of the 20th century, many governments committed to the free market pursued policies of LIBERALISATION based on substantial amounts of deregulation hand-in-hand with the PRIVATISATION of industries owned by the state. The aim was to decrease the role of GOVERNMENT in the economy and to increase competition.
Derivatives
Financial ASSETS that “derive” their value from other assets. For example, an option to buy a SHARE is derived from the share. Some politicians and others responsible for financial REGULATION blame the growing use of derivatives for increasing VOLATILITY in asset PRICES, and for being a source of danger to their users. Economists mostly regard derivatives as a good thing, allowing more precise pricing of financial RISK and better RISK MANAGEMENT. However, they concede that when derivatives are misused the LEVERAGE that is often an integral part of them can have devastating consequences. So they come with an economists’ health warning: if you don’t understand it, don’t use it.
Devaluation
A sudden fall in the value of a currency against other currencies. Strictly, devaluation refers only to sharp falls in a currency within a fixed EXCHANGE RATE system. Also it usually refers to a deliberate act of GOVERNMENT policy, although in recent years reluctant devaluers have blamed financial SPECULATION. Most studies of devaluation suggest that its beneficial effects on COMPETITIVENESS are only temporary; over time they are eroded by higher PRICES.
Diminishing returns
The more you have, the smaller is the extra benefit you get from having even more; also known as diseconomies of scale. For instance, when workers have a lot of CAPITAL giving them a little more may not increase their PRODUCTIVITY anywhere near as much as would giving the same amount to workers who currently have little or no capital. This underpins the CATCH-UP EFFECT, whereby there is convergence between the rates of GROWTH of DEVELOPING COUNTRIES and developed ones. In the NEW ECONOMY, some economists argue, capital may not suffer from diminishing returns, or at least the amount of diminishing will be much smaller. There may even be ever increasing returns.
Direct taxation
Taxes levied on the INCOME or wealth of an individual or company. Contrast with INDIRECT TAXATION.
Discount rate
The rate of INTEREST charged by a CENTRAL BANK when lending to other financial institutions. It also refers to a rate of interest used when calculating DISCOUNTED CASHFLOW.
Discounted cash flow
How much less is a sum of MONEY due in the future worth today? The answer is found by ¬discounting the future cash flow, using an INTEREST RATE that reflects the fact that money in future is worth less than money now, because money now could be invested and earn INTEREST, whereas future money cannot. FIRMS use discounted cashflow to judge whether an INVESTMENT project is worthwhile. The interest rate is a means of reflecting the OPPORTUNITY COST of tying up money in the investment project. To test whether an investment makes economic sense the INCOME must be discounted so that it can be measured against the costs. If the present value of the benefits exceeds the costs, the investment is a good one.
Disinflation
A fall in the rate of INFLATION. This means a slower increase in PRICES but not a fall in prices, which is known as DEFLATION.
Disintermediation
Cutting out the middleman. Disintermediation has become a buzz word in financial services in particular, as competitive and technological changes have done away with the need for established intermediaries. BANKS have seen much of their business slip away, such as lending to companies that now tap CAPITAL MARKETS direct. NEW ECONOMY ¬theorists argued that many retailers would be disinter mediated as the internet enabled customers to transact directly with producers without needing to visit a shop. But this has happened more slowly than they predicted.
Dollarization
When a country’s own MONEY is replaced as its citizens’ preferred currency by the US dollar. This can be a deliberate GOVERNMENT policy or the result of many private choices by buyers and sellers. When it is government policy, dollarization is, in essence, a beefed up CURRENCY BOARD.
The appeal of dollarization is that the value of the dollar is more stable than the distrusted local currency, which may well have a history of suddenly falling in value. By eliminating all possible RISK of DEVALUATION against the dollar, the cost of local companies’ and the government’s borrowing in international markets is reduced, as the currency risk is removed. A big downside is that the country hands over control of MONETARY POLICY to the Federal Reserve, and the right INTEREST RATE for the United States may not be appropriate for the dollarized country, if that country and the United States do not constitute an OPTIMAL CURRENCY AREA. This is one reason that in some countries the local currency has been displaced by another fairly stable currency, such as, in some central European economies, the EURO.
Dumping
Selling something for less than the cost of producing it. This may be used by a DOMINANT FIRM to attack rivals, a strategy known to ANTITRUST authorities as PREDATORY PRICING. Participants in international trade are often accused of dumping by domestic FIRMS charging more than rival IMPORTS. Countries can slap duties on cheap imports that they judge are being dumped in their markets. Often this amounts to thinly disguised PROTECTIONISM against more efficient foreign firms.
In practice, genuine predatory pricing is rare – certainly much rarer than anti-dumping actions – because it relies on the unlikely ability of a single producer to dominate a world market. In any case, consumers gain from lower PRICES; so do companies that can buy their supplies more cheaply abroad.
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