Question

In the period since the financial crisis of 2007-2009, inflation has been low in many countries, while a few experienced outright deflation. Why might unexpected deflation be of particular concern to someone managing a bank? Unexpected deflation is associated with ________ of borrowers, as the nominal value of their assets _______ but the dollar amount of their liabilities _______ . This weakens creditworthiness and can lead to ________ lending as asymmetric information problems worsen. In turn, ________ credit supply can diminish economic activity, leading to _________ defaults, a deterioration in the quality of the bank’s balance sheet and ultimately to bank insolvency.

Answer 1

In the period since the financial crisis of 2007-2009, inflation has been low in many countries, while a few experienced outright deflation. Why might unexpected deflation be of particular concern to someone managing a bank? Unexpected deflation is associated with (falling net worth) of borrowers, as the nominal value of their assets (falls) but the dollar amount of their liabilities (remains the same) . This weakens creditworthiness and can lead to (reduced) lending as asymmetric information problems worsen. In turn, ( reduced) credit supply can diminish economic activity, leading to (increased) defaults, a deterioration in the quality of the bank’s balance sheet and ultimately to bank insolvency.

Step-by-step explanation:

Deflation is described as a period where there is persistent fall in prices of good and services, this affects different people like pensioners, lenders and borrowers in different ways.