Deflation – Meaning, Reasons, Measures to Control

Deflation – Meaning :

Deflation means an economic scenario where there is decline in general price levels of commodities and services. When the overall price level falls because of which inflation rate becomes negative, it is called deflation. Deflation increases the real value of money and one can buy more goods and service with it than before.

Main reasons :

1.Decreased money supply :

When the supply of currency in an economy decreases due to the actions taken by the Central Bank / Reserve Bank in case of India then it leads to deflation.Deflation is directly related to the supply and demand of money.

Deflation occurs when the supply of money increases slower than the supply of goods and services.

2. Borrowings from public (excessively) :

When the government borrows money from the public through issue of bonds and any other negotiable instruments excessively then it leads to transfer of public money in to the hands of government. And if the government spends comparatively lower then it causes deflation.

3.Improper taxation policy :

When government imposes heavy taxes to reduce the disposable income with the people ,This leads to the decline in both consumption and investment expenditure and results in deflationary conditions.

4.Reduced Government spending :

When the government decides to reduce its public expenditure, it leads to decrease in employment multiple times .This will lower aggregate demand, discourage investment and affect the economic activity of the economy adversely.

5. When the availability of credit becomes costly :

When the Reserve Bank of India takes measures to lower the impact of inflation by way of raising the bank rate, sale of government securities, raising the cash reserve ratio, then it leads to a considerable decrease in money in the hands of public as a result of increased borrowing costs. If this happens for more than a tolerable level then it affects the economy adversely.

6.Decrease in Demand :

Deflation occurs when the supply of money increases slower than the supply of goods and services. In this situation, there will be more demand for money than for goods and services. Then the demand for goods and services will decrease considerably than the previous level which results in deflation.

Measures to control deflation :

1.Credit Expansion :

The Reserve bank of India and the commercial banks should implement a policy which results in credit expansion to promote business and industry in the country. Bank credit should be made easily available to the public and business concerns.

2. Lowering the Taxation :

Government should change the taxation policy in such a way that the number and burden of various taxes levied on commodities and services will become lowered. Then the prices of goods and services will become reduced then previous one. This will lead to tremendous increase the purchasing power of the people. As a result, the demand for goods and services will increase. And sufficient tax relief should be given to businessmen to encourage investment.

3.Repayment of Public Debt :

Government can increase the money in the economy by way of repaying the old public debts during the times of deflation. This would result in an increase in the amount of currency in the economy which helps to eradicate the deflation.

4. Initiatives to attract more investments :

Government should formulate and implement favorable trade policies which are investment friendly. This will attract the attention of foreign institutional investors and domestic entrepreneurs to set up their businesses in the economy. This entire scenario will definitely lower the deflation.