Deflation

In the words of Crowther, “Deflation is that state of the economy where the value of money is rising or prices are falling”. Deflation, in fact, is a situation where falling prices are accompanied by falling levels of employment output and income.

Causes of Deflation:

The process of deflation is just the opposite of inflationary process of inflationary process. Deflationary process comes into existence when the level of money income falls relatively to the current supply of goods and services. Deflationary process may occur due to a fall in the private investment or persistent unfavorable balance of payments or a continued government budgetary surpluses or sudden increase in the total output, or by action of the central bank to raise the discount rate or by selling securities or due to the combined effect of all these factors.

Professor Friedman is of the view that deflationary spiral takes place when the money supply is held to a rate of growth less than the economy’s potential output. Like inflation, deflation also breeds deflation. Deflation can be controlled both by Fiscal and Monetary measure. The disciples of J.M. Keynes are strongly of the view that prices can be stabilized more by fiscal measures than by monetary steps. They say the task of increasing the demand for goods and services could be done by government by increasing public spending, by reducing taxes, by stimulation private investment or private consumption or a combination of all these.

Effect of Deflation on different sections of the society:

1. Read more in Economics

   « Importance of Productivity for an Economy and Factors Contributing to Productivity and Its Impact on Sustainable Economic Growth

   The Economy »

   Over production:

   When prices are falling, the producers buy material and other inputs at higher prices and are forced to sell the products at lower prices. It eventually results in over production of commodities.

2. Traders lose:

   During deflation, the traders purchase goods at higher prices and have to sell later on at lower prices due to deflationary trend. Thy, thus, lose in the bargain.

3. Investing class:

   The equity holders lose during deflation and debenture holders gain when prices fall.

4. Fixed Income group:

   The pensioners, wage earners, gain during deflation as the wages, pensions etc do not decrease with the fall in the prices.

5. Consumers:

   When the prices of the commodities fall, the consumers, whose income is fixed, gain.

6. Creditors and debtors:

   During deflation, the creditors tend to gain and the debtors tend to lose.

7. Tax payers:

   The tax payers lose during deflation as the value of money rises in this period.

8. Private sector units:

   The private sector units suffer when their price of goods falls.

9. Industrial unrest:

   In the deflationary period, there are industrial disputes and unrest in the industrial sector.

10. Pace of economic growth:

    During deflation, the pace of economic growth gets a set back. Reduction in output and increase in unemployment retards economic growth.