Why is an economic depression bad for consumers even though prices are cheaper?

Question

Why is an economic depression bad for consumers even though prices are cheaper?

In: 88

Answer 1

Have you heard of “*fractional reserve banking*”? Basically banks are allowed to lend 90% of their customer’s deposits.

So Mister A puts $500K on his account, of which the banks lends $450K to Mister B, who uses it to buy something from Mister C, who puts it in his account, of which the bank lends $405K to Mister D, and so on…

Before you realise it, the bank has artificially put into circulation $4.5 million out of Mister A’s seed $500K. The bank acts as the heart of the economy, and pumps cash through the arteries. This creates what is called the “*velocity of money*”. How fast money changes hand.

With that established, when you have an economic depression, two things happen. The bank might decide that lending money to Mister B is too risky, or Mister B. might consider it wiser to not purchase from Mister C.

Before you realise it, the velocity of money drops like flies, and the total that the bank artificially created is no longer $4.5 million. Maybe it’s only $2.5 million.

Even if prices drop, everyone has less money that they can get or spend. This causes businesses to close and people to loose their jobs, which makes an already bad situation become worse.