What is Deflation, Remedies and Causes of Deflation

Wed, 03/27/2013 - 09:02 -- Umar Farooq

What is Deflation

The concept of deflation is opposite to inflation. It is defined as a situation when the general income level and price level are falling. It is also known as negative inflation. During deflation the income level falls against the available supply of goods and services. The stage of deflation arises when.

  1. Prices are falling continuously
  2. People prefer to hold money with them and do not keep goods.
  3. The available supply of goods does not dispose off on the prevailing prices.
  4. People expect more reduction in prices thus reduce their consumption to bring prices down.

Causes of Deflation

The main causes of deflation as under.

  1. Fall in demand for goods and services are the primary causes.
  2. People due to one reason or the other reduce their consumption on the purchase of goods & services due to which prices start falling.
  3. Sometime people start saving more than before which causes reduction in the aggregate demand and the available supply is sold at falling prices.
  4. If due to some reason the level of investment in all economy is falling. It will negatively affect the economy. The demand for capital goods will fall and prices will tend to come down.
  5. Decline in incomes of the people can also cause deflation in the economy. Due to reduction in the income level of the people the aggregate demand for goods services falls short of the aggregate supply, thus prices start falling.
  6. Excess of supply due to some reasons can also cause deflation because in this case the aggregate supply will exceed the aggregate demand hence the price level will fall.

Remedies for Deflation

Following are the remedies suggested to control deflation.

  1. If the central bank reduces the interest rate then the commercial banks will also advance loans at a lower interest rate which will boost up the investment, resulting increase in demand for capital goods and employment. Thus incomes will increase price level will start rising.
  2. In order to increase the aggregate demand the government has to increase its expenditures. By increasing expenditures incomes of the people will rise and price level will tend to move upward.
  3. By Printing extra money through the central bank and injecting in the economy the government can increase the aggregate demand which will further enhance the price level.
  4. By encouraging the private sector for investment through various immunities like subsides or tax reduction the aggregate demand can be used
  5. People should start using their savings on consumer goods or investment.
  6. To increase exports and reduce the imports, the income level of the people and prices level can be raised