Pigou effect

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The Pigou effect is an economics term that refers to the stimulation of output and employment caused by increasing consumption due to a rise in real balances of wealth, particularly during deflation.

Wealth was defined by Arthur Cecil Pigou as the sum of the money supply and government bonds divided by the price level. He argued that Keynes' General theory was deficient in not specifying a link from "real balances" to current consumption and that the inclusion of such a "wealth effect" would make the economy more 'self correcting' to drops in aggregate demand than Keynes predicted. Because the effect derives from changes to the "Real Balance", this critique of Keynesianism is also called the Real Balance effect.

The Pigou effect and Japan

If the Pigou effect always operates strongly, the Bank of Japan's policy of near-zero nominal interest rates might have been expected to end the Japanese deflation sooner.

Other apparent evidence against the Pigou effect from Japan imports from Japan may be its long period of stagnating consumer expenditure whilst prices were falling. Pigou hypothesised that falling prices would make consumers feel richer (and increase spending) but Japanese consumers tended to report that they preferred to delay purchases, expecting that prices would fall further. A similar, reverse Pigou effect happens throughout the world in consumer electronics because of depreciating prices (this is sometimes called the Osbourne effect).



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