These days India is facing deflation. I was curious to know more about it; hence I found that out and am sharing the same with you. Deflation is opposite of inflation. The definition of deflation can be put as the real value of money increases. Inflation reduces the real value of money over time.
Why does deflation happen? What are its effects?
Deflation happens when there is a decrease in money supply and credit. When there is a shortage of money supply, money becomes dearer and more goods can be bought from little money. one other situation is the demand for goods decreases and consumers are not interested to purchase items causing the consumption levels to decrease which in turn affects the overall economic activity.
The other factors are that the government itself starts spending less thinking there might be a need for money in the future and try to save. For example, instead of building a bridge today the government decides to build it couple of years later. This will affect the laborers who are dependent on the construction work. Since they don’t have any work in near future, they try to save up the cash that they have and stop spending. When they stop spending the prices of the goods also falls down as there is no demand for the goods. Since there is no demand for the goods, the producers of the goods stop producing the goods which in turn causes problems for the employees. These producers start firing their employees and many people start losing their jobs. When these people lose their jobs, their purchasing power decreases.
As the quantity of money in circulation decreases, it becomes more valuable. For consumers, deflation means higher purchasing power. Their money buys more services and goods for them. It is a period of time which is fruitful for those who have saved their money.
Very informative article dude.. Nice one.
@Karthik : Glad you liked the post. Keep Visiting. 🙂
Nice simple treatise on the subject of deflation. Put in layman’s terms and accurately described. We engineers can bring down complex subjects to simpler terms and you have proven it!
You are right in analysing many factors that lead to deflation. But there could be many more. Even if purchasing power of the people has not reduced, sometimes people hold back spending only because they might be waiting for better deals or for the fear of depreciation.
Also, inflation is measured as a weighted average of wholesale price index over the last year. That means even if the prices have not gone down, there is deflation because of a very high value same time last year [:)]
Thank you so much for the kind words.
Agreed with your views.