DEFLATION (Detail)

DEFLATION 

CONCEPT OF DEFLATION

Deflation is the opposite of inflation. It is defined as the situation of a fall in the general price level or an increase in the value of money.

According to Crowther, ”Deflation is the state of the economy where the value of money is rising or the prices are falling.”

Causes of deflation

1. Reduction in money supply and bank credit

If the government or central bank reduces the supply of money and bank credit, it will reduce the aggregate demand. Consequently, deflation occurs.

2. A sudden increase in output

If there is a sudden increase in the output, then the money supply remaining constant, the aggregate supply will exceed the aggregate demand. Consequently, deflation occurs.

3. Increase in taxes

The government may increase the rate of taxes. This reduces the purchasing power of people which leads to a fall in the general price level.

4. Reduction in government expenditure

If the government reduces public expenditure, this will result in low consumption and a decrease in aggregate demand. This will lead to deflation.

5. Public borrowing

If the government borrows from the public, it results in the transfer of money from the public to the government. This reduces the aggregate demand and causes deflation in the economy.

Consequences/ Effects of deflation

1. Effect on production

Deflation adversely affects producers. During deflation, the cost of production does not fall as rapidly as the prices of goods and services. This results in the loss to the producers.

2. Effects on the distribution

Deflation also affects the distribution of income and wealth. Deflation distributes income in the favor of the lower and middle-class people and adversely affects the interest of the business persons. Due to the falling prices, the incomes of traders, business persons, etc will fall.

3. Effects on economic growth and employment

There is an adverse effect of deflation on economic growth and employment. Due to the fall in prices, business profit declines, investment declines, and finally, production declines. This leads to a fall in both income and employment.

4. Other effects

a. Tax revenue of government falls

b. Consumers gain due to the fall in price

c. Banking business suffers due to falling in investment

d. Both public and private sector business suffers losses

e. Social and public life of the country gets disturbed.