What is Deflation?
Deflation is an economic concept. It refers to a situation in which the prices of the commodities and the services fall considerably. Deflation is caused due to many factors such as changes in supply and demand forces, and fluctuations in the currency supply.
We are much aware of the inflation and its effects due to business news. Inflation refers to the rising of prices. In fact, we are worried about the inflationary prices. But if the prices go down considerably, then is it a good sign? Well, not actually! This reduction of prices is nothing but deflation. It may sound like good happening for all but in reality, it reflects the deterioration of the economic conditions of a country.
Let us understand the various elements that lead to deflation. Actually, there are many causes of deflation but we will focus the main ones here.
Capital Markets of the country
Due to severe competition in the market, companies may reduce the prices of their manufactured goods. This reflects a change in the capital structure. Companies will get opportunities to raise their capital by reduction of interest rates, modification of banking practices and so on. As a result, prices decreases and the supply of commodities increases, leading to a situation of deflation.
Enhanced productivity – a reason for deflation
This may sound surprising to read. But yes, if productivity is enhanced, then it can lead to deflation. We are witnessing tremendous developments in the field of technology. This advanced technology is utilized for introducing creative solutions to increase the overall productivity and efficiency of the economy. It results in lowering of prices so that the consumers can get access to the products easily. It is true that technology may have an impact on only certain industries. But it cannot be refused that some of the developments have striking effects on the overall economy of a nation.
Reduction in the supply of currency
You must have a question immediately popping in your mind: How can the currency supply reduce? The currency is controlled by the central banking practices and systems. Now-a-days, most of the spending is carried on by credit means. If the lenders enforce restrictions on the credit systems, then consumers will tend to spend less on the commodities and luxuries. As a result, companies will be forced to decrease the prices. Thus, when the supply of currency is reduced, then prices are also reduced. People cannot afford to make purchases of essential commodities and expensive items. This is the relationship between currency supply and the concept of deflation.
Stringent measures adopted by government and business spending
The spending by government, business entities and consumers has a considerable impact on deflation. It the government cuts its spending activity, and then it may lead to deflation.
Conclusively, even if deflation refers to reduction in prices, it can lead to a dangerous situation for an economy as a whole. Though some nations try to recover from the losses, but the long-term effects are visible enough. It is necessary to understand the concept of deflation, causes and its effects to evaluate the current economic situation.
Deflation is opposite of inflation. It is a situation when price of a commodity or service is lower than in the previous period. One may assume that deflation is good for an economy but reality is something different. To some degree, deflation can be good as it gives consumers greater purchasing power but constant fall in prices can have negative effects on growth and economic stability of a country.
Deflation occurs when the inflation rate falls below 0%. A reduction in money supply or credit availability is the reason for deflation in most cases. This can be a good sign for the consumers, since the prices of all the goods and services decrease which in turn increases the purchasing power of the people. Investing in high return bearing products like real estate, blue chip shares, etc. should be thought of in such a situation. Though it may sound good, in reality it is not good as such, deflation leads to many bad incidents like loss of goodwill, rise in unemployment, etc. Deflation leads to a decrease in demand and increase in supply.
Deflation is a word on the lips of more financial experts these days. The term refers to a fall in prices (despite no change in product quality or quantity) and is the opposite of inflation. But like inflation, deflation can have a devastating impact on individual pocketbooks and the broader economy. This article describes the various causes and effects of deflation. One can easily go through this and clear their queries.
Inflation and deflation… both bad for the economy. I am glad to know about the difference between these two. Just because inflation can have dire effects on the economy, it doesn’t mean the opposite thing is a better option. Like people always say - everything should be in moderation, or something bad will happen.