Deflation: Understanding Its Causes and Effects
- Vivan Mittal
- Oct 19
- 3 min read
By Vivan Mittal
Deflation is a term used in economics to describe a sustained fall in the general price level of goods and services in an economy over a period of time. In simple words, it means prices are going down, and the value of money is going up. While that might sound like good news at first — after all, who wouldn’t want cheaper goods? — deflation is actually a complicated situation that can either help or harm an economy depending on its cause.
Economists often divide it into two types: benign deflation, which can be healthy, and malign deflation, which is usually harmful. One of the most prominent examples of deflation in recent times is Japan. The Asian country suffered persistent deflation with a cumulative fall in consumer prices of almost 4% between 1998 and 2012,anor example is China, which recorded a successive series of declines in its Consumer price index (CPI), which began to fall in January 2023 and continued till July 2023, dropping from 104 points in January to 102.7 points in July.
What are the types of deflation, and what triggers them?
Benign deflation is a situation where the decrease in prices is due to favorable developments within the economy. It arises as a result of improved productivity, innovation, and efficiency within companies. For example, the improvement in technology has reduced the cost of producing phones, televisions, and computers; hence, the price of these commodities has fallen over the years. Despite the drop in price, the firms still get profits because their costs have fallen further.
In benign deflation, people are still employed, businesses are still investing, and overall output rises. Lower prices are a boon to consumers because real income increases-in other words, what their money can buy rises. For example, if your salary stays the same but prices fall, then you can buy more. This brings higher purchasing power and better standards of living and more economic growth in the long term.
Malign deflation is much more virulent, however. Price decline occurs because demand is weak, not supply strong. When consumers cut back on spending—perhaps because of job losses, low confidence, or high debt—businesses struggle to find buyers for their products. The only way they may be able to attract buyers is by reducing prices, which can invite a self-reinforcing cycle.
If prices are continuously expected to fall, people will postpone purchases in anticipation of even lower prices. Businesses next make less money, and consequently, cut wages or lay off workers, thus reducing spending even further. This downward spiral can lead to recession and high unemployment.
Malign deflation also makes debts harder to repay. When prices and incomes fall but the amounts lent do not budge, the real burden of debt rises. Households and companies can get trapped, unable to spend or invest.
How is Deflation Measured?
Economic measures such as the Consumer Price Index (CPI) measure deflation.
The CPI analyses the prices of a collection of widely purchased products and services and provides monthly changes.
If the CPI shows a price decline over the prior period, it indicates economic deflation.
In contrast, collective price increases signify inflation.
This dynamic measurement allows economists and policymakers to observe price movements and make informed monetary and fiscal policy decisions.
How Can Governments and Central Banks Respond?
Monetary and fiscal policies have been utilized to reverse malign deflation whenever experienced by an economy. The authorities may reduce the interest rates, which would encourage people to borrow money and, in turn, spend it. They may also use quantitative easing, a process whereby they pump more money into the economy to raise demand. With more money in the economy, banks are more willing to give out loans, and hence borrowing from banks increases, and in turn, spending by individuals increases.
Conclusion
Deflation isn’t always bad — when it comes from innovation and productivity, it can make life better and economies stronger. But when it’s caused by weak demand and falling confidence can trap a country in a long, painful slowdown. The key difference between benign and malign deflation is whether prices fall for the right reasons. Understanding that difference helps policymakers respond correctly —because in economics, cheaper prices aren’t always a good thing.
Bibliography
https://www.vedantu.com/commerce/deflation#:~:text=Summary,debt%20rates%20and%20reduced%20investment.
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