What is Deflation?

In common usage deflation is generally considered to be "falling prices". But there is much more to it than that. Often people confuse deflation with disinflation or with Depression (as in "the Great Depression"). These three terms are related but not synonymous. According to Investorwords.com the definition of Deflation is "a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. The opposite of inflation."
iy Inflation vs. Deflation Its possible for the economy to be experiencing inflation and deflation at the same time. Seldom do the prices of goods and services all increase or decrease simultaneously. Instead, some prices will go up over a period of time, while other prices go down. In that case, there can be inflation and deflation happening at the same time. One of the government remedies for deflation is to put more money into supply by purchasing securities. Increasing the money supply too quickly can lead to inflation and even hyperinflation, a situation in which inflation happens very rapidly. Inflation and deflation are both parts of a properly functioning economy. They typically happen in cycles and can correct themselves without any government intervention. However, in extreme situations, like the Great Depression, the economy does need a helping hand from the Feds.

Causes of Deflation

Deflation is nothing but a fall in the general price level. In order to understand the circumstances under which Deflation occurs and affects an economic condition, one needs to go through the causes of Deflation. Causes of Deflation: Capitalism characterized by sufficient existence of competition, is regarded as one of the factors responsible for the emergence of Deflation. In this case, with the improvement in the capital stocks, competition increases million fold. Escalation in the total number of competitors boosts up the supply of goods, indicating that the prices must decrease in order to stabilize the demand, thereby bringing in Deflation. Capitalism also brings in innovation and

efficiency, which also contributes towards the initiation of Deflation. In an economy based on credit, a decrease in money supply results in remarkably less lending trend, followed by a sharp decline in the money supply. As a result, there occurs a sharp reduction in the demand for goods. A decline in the demand is followed by a decline in the prices, owing to the development of a condition called the supply glut. Gradually, this assumes the form of a deflationary spiral, where the prices go down below the costs of financing production. With the advent of deflationary spiral in an economy, the commercial sector of the country stops incurring profits, despite lowering the prices of their finished products. Ultimately, a situation arises where this commercial sector is forced to become liquidated. In order to prevent or slacken down the deflationary spiral, it is necessary for the banks to avoid the collection of non-performing loans. According to the monetarist viewpoint, Deflation occurs when there is a decrease in the velocity of money, and/or in the amount of monetary supply per person. Deflation helps the economy grow and develop at a rapid pace, even faster than the creation of hard money.
To sum up, deflation arises due to the following conditions stated below:

Decrease in the money supply

Increase in the supply of goods Fall in the demand for goods Escalation in the demand for money

What are the Remedies of Deflation that could be taken for stopping Deflation?
Deflation tends to get self-corrected on account of the fact that, in absolute terms, demand cannot fall below a certain level. Another factor worth noting is that while it may be possible to choke off inflation. (i) Drastically reducing the availability of credit. (ii) A hefty increase in rate of interest. (iii) An effective system of price controls and rationing, reversing these measures may network to remedy a deflation. Thus, for example, if credit is made more easily available and at a low rate of interest, still the investors cannot be forced to borrow and invest. The reason for their not investing lies in' deficiency of effective demand. Investment will not pick up unless marginal efficiency of capital increases. This implies that the authorities should take up the policy of directly increasing public expenditure. Similarly, when it comes to price controls, it may be possible to fix the maximum prices of selected items, but it is very difficult to fix and enforce minimum prices. The public at large cannot be forced to pay more when it does not want to. The policy of minimum prices can be applied only where producers are buying inputs like labor. But if that is done, it will only increase the cost of production and the phenomenon of deficiency of demand will become stronger. It follows, therefore, that Keynesian view that only fiscal measures can be really effective in curing deflation has a greater weight in it. When government increases its expenditure, there is a direct injection of expenditure and demand in the economy. It is more so if the government expenditure is incurred on such welfare measures as benefit the poorest of the people since they have the highest marginal propensity to consume. Keynes also adds that the government should not worry about the "productive" nature of its expenditure. The objective should be to create demand and that is best done when the expenditure incurred is under heads of "consumption" and "non-developmental", etc. Another remedial measure in reviving investment and demand is a reduction in rate of interest. However, Keynes found that this measure could work only up to a limit. Once the rate touches what the market thinks as the "floor level", it refuses to fall further and loses its value as a remedial measure. In addition, the authorities can also adopt the policy of tax concession and subsidies. They can use these measures so as to make certain investments (particularly, the laborintensive ones) profitable enough. The authorities should rely more on deficit spending

for meeting their expenditure needs and, in the process, lower both direct and indirect taxes. However, as regards customs, export duties should be lowered or abolished so as to encourage exports while import duties should be raised to protect the domestic industry and employment. The developments in post-Keynesian economics suggest that the authorities should adopt a policy of increasing the size of their budget. This, in itself, is expansionary in effect. And if in addition, the government also resort to deficit financing, the expansionary impact is further enhanced.

Inflation
What Does Inflation Mean? The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.