Deflationary spiral | Inflation | Finance & Capital Markets | Khan Academy

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So in a normal economy
we know that employment

will drive overall demand.

If we have high employment
or low unemployment,

then people are going
to have more jobs,

and they're going to
have higher wages,

and that will have
higher demand.

Or if the other way goes
around, if they lose their jobs,

demand is going to go down,
wages will start to go down,

and people aren't going to
have money in their pockets.

So employment drives demand.

And we can view the
demand-- and I'm

making a huge
simplification here--

demand will drive production.

Or maybe we could
think of it as supply.

It'll drive supply, and it
can also be a driver of price.

And of course, there is a little
bit of a negative feedback

loop for both of these things.

If the demand is high
and the price goes high,

that might produce a little
bit of negative feedback

on the demand.

Instead of an arrow, this line
here means negative feedback.

I'll put a little
negative sign here.

And let's say the demand is high
and then the supply goes high.

Well actually, the
supply going high

would drive the
price going down.

So maybe I should draw a
negative feedback like here.

High supply would
mean lower price.

But that's not what I want
to focus on in that video.

And we could keep
adding more lines here.

But this is roughly
simple take on it.

But the general idea
is supply and price

will then drive corporate
profits, or just profits

in general, even for an
individual business owner.

And then profits are
going to drive employment.

Now, let's imagine a scenario.

We are in a bad economy, maybe
a depression-like economy.

So in that situation,
you could start really

at any point in this circle.

I'll just start at employment.

So let's say employment
is really low.

That's going to make
demand really low.

And if demand is
really low, then supply

is going to go down, and
price is going to go down.

And then that's going
to make profits go down.

And that's going to make
employment even lower.

And so what we find ourselves
in this kind of recessionary

or depression area
environment, this

would be called a
deflationary spiral.

And it's a spiral
because a bad economy

is driving lower
prices, which is

in turn driving a bad economy.

And to make matters worse, if
this continues long enough,

or if these price declines
are severe enough,

you could imagine
people saying, look,

I have this dollar in my pocket.

I'm not going to spend
this dollar because, one, I

might lose my job
at any moment, and I

know that that dollar is
becoming more powerful,

that I can buy more
every minute that I wait.

So as the price goes down,
so as all of this scary stuff

happens-- so the
employment is going down,

profits are going down,
prices going down-- this

makes people not
hoard goods the way

that they would do in
an inflationary spiral.

But it makes them hoard money.

And why it's ultra scary
for central bankers

or for governments
is they start to not

have as much control
over the economy.

They can't just run
the printing press

and try to stimulate the
economy in this situation,

because if they did people are
so conservative right now--

You could imagine
maybe a depression

is going on for years
and years and years.

And let's say that they take
some type of a helicopter--

And this isn't how you actually
distribute money to the money

supply, but it's just to
show an extreme example.

So they take a
helicopter, and they

start dumping cash on people.

They print cash, and they
start dumping it on people.

So every man, woman, and child
in the country gets a $10 bill.

Well, if people are really
scared and really afraid,

they're just going
to take that $10 bill

and stuff it into
their mattress,

and it's not going
to change anything.

That dollar isn't
going to actually enter

into the money supply.

The velocity on it will be 0.