CA Subhash Srinivasan
Deflation is just the opposite of inflation. It is essentially a matter of falling prices. Deflation, according to Prof. Paul Einsig “is a state of disequilibrium in which a contraction of purchasing power tends to cause, or is the effect of, a declining of the price level.” Deflation is that state of falling prices when the output of work by productive agents increases relatively to ,money income. Deflation arises when the total expenditure of the community is not equal to the value of output at existing prices. Consequently, the value of money goes up, and prices fall. In short, deflation is a condition of falling prices, accompanied by the decreasing level of employment, output and income.
Effects of Deflation
Though the effects of deflation are just the opposite to those of inflation, deflation also poses its own menacing threat to economic stability in a system. Effects of Production. Deflation adversely affects the level of production, investment activity, employment, and income level in an economy. During deflation, when .prices are falling rapidly but the cost of production does not fall correspondingly, producers incur heavy losses and curtail employment and output. This causes aggregate income to fall and aggregate demand to decrease, with prices falling further and so on. Business pessimism emerges and gradually is commonly described as “poverty in the midst of plenty” because economic activity, income, output, and, employment diminish miserably and ample resources remain unutilised or underemployed. Much of the poverty during deflation due to deficiency of demand. Lack of effective demand causes poverty in the midst of plenty.
Effects on Distribution
Deflation has also an adverse effect on the distribution of wealth and income in the community. The share of profit earners in total income declines while that of wage earners increase. Thus, deflation, favours the consumer class and not to producer class. During deflation, creditors tend to gain at the expense of debtors. Investors in fixed-interest bearing securities, rentiers etc., and fixed-income earners gain by the rising value of money. In general, all fixed-income earners gain and all flexible-income earners Joss in times of deflation. During deflation there will be a stimulus for savings but as the general income level is low, the ability to save will get reduced. Deflation benefits the middle class at the expense of the richer classes. But its dampening effect on production is bad from the society’s point of view, as it reduces the level of employment. Increasing unemployment leads to further social discontent. In this sense, deflation is worse than inflation.
Control of Deflation
Broadly speaking, deflation can be checked by making attempts to raise the level of aggregate effective demand. Effective demand can be uplifted partly by inducing the people to spend more on consumption and partly by stimulating investment expenditure in the economy. Marginal propensity to consume in an economy can be raised by a redistribution of income from the rich to the poor classes. Thus, anti-deflationary measures involve a progressively high income-tax and other forms of direct taxation and a subsidies programme to poor people. Similarly, measures should be taken to induce investment. In this context, a lowering of the rate of interest by increasing money supply, provision of adequate tax relief to corporation’s programme of public investment to provide social overhead capital, and public projects which do not compete with private enterprise and rendering all facilities to raise marginal efficiency of capital in the private sector, are very essential. As an antideflationary measure, a programme of public investment should be financed by borrowing rather than taxation. Deficit financing may also be helpful in this context. There should be proper planning and public works policy and the programme should be properly implemented. In short, deflation also should be attacked by various other weapons. A monetary or fiscal policy alone cannot be very effective. There should be a well-knit co-ordination of monetary and fiscal policies with other measures to combat deflation.
Inflation vs Deflation
Both inflation and deflation are socially bad, but inflation may be considered to be the lesser of the two evils. Inflation is unjust in its Effects on the Following Counts:
On the Other Hand, Deflation is Inexpedient and, Therefore, Not Advisable. It is Considered Inexpedient for The Following Reasons:
This clearly shows that though Inflation is Unjust, it is better Than Deflation. Keynes Showed a Preference for Inflation, because it is the lesser of the two Evils. The Following Point Bring out the Fact that Inflation is a Lesser Evil:
Deflation Affects the Entire Economic Life of a Country. The Different Sections of Society are Affected in the Following Manner:
Producers and Traders:
The producers are adversely affected on three counts: (a) the production costs at a time of deflation do not fall as rapidly as the prices of the fmished products, (b) whenever a producer buys raw materials, etc., he has to pay the higher price for them but when the fmished product reaches the market the prices of raw materials will have fallen still further and the producer will be compelled to sell his product at a reduced price, and (c) the demand for commodity also goes down at a time of deflation. The traders are also adversely affected by deflation because the prices are high when they make the purchases, but by the time they are able to sell the goods, the prices undergo a further fall. Likewise, deflation also hits the farmers, particularly the small farmers, who do not have any reserves to fall back upon.
There are two types of investors in a capitalist economy. Firstly, those investors whose income is fixed. Secondly, those investors whose income is variable. The fixed income investors actually gain by deflation, the reason being that their income is constant, while the prices continue to fall as a result of deflation. On the contrary, the variable income investors are adversely affected by deflation, the reason being that their income goes down consequent upon deflation.
Salaried and Labouring Classes:
These classes are beneficially affected by deflation. The reason is that with the fall in prices, it is not easy to cut down the wages of the workers. Any attempt to reduce the wages is stoutly opposed by the trade unions. Likewise, it is not possible to cut down the salaries of the employees. Hence, both of these classes gain as a result of deflation. Their money income remains constant while the prices of goods and services decline. iv. Consumers. The consumers are beneficially affected by deflation. Due to falling prices, the purchasing power of money rises up, enabling the consumers to buy more goods and services than before. v. Debtors and Creditors. Creditors gain while debtors lose as a result of deflation. The creditors gain because whatever amount they receive in the form of interest, etc. carries now a higher purchasing power than before. The creditors also gain because at a time of deflation, the demand for consumption loans goes up and the creditors can charge arbitrary rates of interest on them. But the debtors are the losers at a time of deflation. The farmers are the worst hit by deflation because the burden of indebtedness goes up as a result of falling prices. Deflation creates industrial unrest in the country. The economic development suffers a set-back and the economic, social and political life of the country gets upset. Hence, deflation is extremely harmful for the economy of a country. “Inflation is unjust; deflation is inexpedient. or the two, deflation worse.”—(Keynes).
Explanation: Inflation vs. Deflation
Which is better, inflation or deflation? Both inflation and deflation are harmful for society, but inflation may be considered to be the lesser of the two evils. In the words of Keynes, “Inflation is unjust; deflation is inexpedient. Of the two, deflation is worse.”
Inflation May be Considered to be Unjust on the Following Grounds :
Deflation is Considered Inexpedient on the Following Grounds:
He considers inflation better than deflation on the following grounds:
SYNOPSIS ON DEFLATION :
What is deflation and why is it bad for the economy?
Deflation is a fall in the price of goods and services. Deflation occurs when the inflation rate falls below zero per cent. This is the opposite of inflation.
When the inflation rate is negative, the economy is in said to be in a deflationary period.
Why does deflation happen?
A fall in spending — it could be personal spending or a cut in government expenditure — leads to deflation. The decline in the supply of money and credit thus leads to deflation.
So, if money-supply decreases; supply of other goods increases, demand for money rises, and the demand for other goods slips, it is deflation.
What are the consequences of deflation?
Deflation leads to a lower level of demand in the economy. It increases the real value of money. It also increases unemployment.
In a deflationary environment, those sectors with a high proportion of variable costs are likely to benefit from falling input prices, according to Goldman Sachs.
What could happen if India slips in deflation?
India would see deflation or reduction in general price level from next month due to slackening demand, according to financial services firm Goldman Sachs said.
“We expect yearly headline WPI inflation to fall rapidly below 1 per cent in March. And enter a period of deflation beginning in April, which could last till end-2009 due to not only continuing demand destruction but also a sharp step-up in the base,” it said in a research report.
“There will be negative inflation for a few weeks in the first quarter of next fiscal, driven largely by higher base effect but we do not expect a pronounced deflationary trend in the economy,” Dun and Bradstreet chief operating officer Kaushal Sampat said recently.
Is deflation good for you as prices are falling?
A fall in the prices may sound good for consumers. But it is not actually good. The lack in demand may push companies to further lower prices.
This can lead to a situation where the prices of product fall bellow the cost of manufacturing a product. This in turn forces the companies to cut production, slash jobs and shut down business till demand picks up. This worsens the situation.
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