Deflation

A common theme among many economic policymakers, financial market

participants, and the media is that rich industrialised nations face a high risk
of deflation, and that deflation always harms economic performance and so
must be combatted with aggressive macroeconomic stimulus. Such broad
assessments are misleading, and under certain circumstances may lead to
misguided policies. More clarity on the topic is required.
Deflation is an economic theory, which deals with reduction in the price
levels or in the prices of a type of good or asset. When government prints
money, it causes inflation. Deflation generally occurs when the supply of
goods rises faster than the supply of money, which is consistent with these
four factors. These factors explain why the price of some goods increases
over time while others decline.
Good deflation occurs when businesses are "able to constantly produce
goods at lower and lower prices due to cost-cutting initiatives and efficiency
gains". It is a good deflation since it allows "GDP growth to remain strong,
profit growth to surge and unemployment to fall without inflationary
consequence."
By contrast bad deflation results when demand runs chronically below the
economys capacity to supply goods and services, leaving an output gap.
That prompts firms to cut prices and wages; that weakens demand further.
Debt aggravates the cycle: as prices and incomes fall, the real value of debts
rise, forcing borrowers to cut spending to pay down their debts, which ends
up making matters worse.
Bad deflation is a more difficult concept to define. "Bad deflation has
emerged because even though selling price inflation is still trending lower,
corporations can no longer keep up with cost reductions and/or efficiency
gains."
In essence this is really factor 1 "The supply of money goes down" from our
list. So "bad deflation" is caused by a relative decline in the money supply
and "good deflation" is caused by a relative increase in the supply of goods.
There are several effects that deflation has on a nations economy.

For instance, deflation results in the improvement of production efficiency,

due to lowering of the overall price of commodities. The production efficiency
of a country develops at a time when the economic producers of goods and
services are propelled sufficiently by a promise of enhancing their profit
margins, by improving the overall standard of their products. At this point,
the consumers are required to make low payment while buying those goods.
This increases the purchasing power, and culminates into an economic
condition called Deflation.
However, deflation generally exerts negative impact on a country's economic
conditions. This is because the advent of Deflation acts as a tax on the
borrowers and the liquid asset holders simultaneously. This in turn, acts as a
benefit, as far as the liquid cash and asset holders and the savers are
concerned. Deflation discourages both investment and expenditure. In
contemporary economic conditions, the penalties associated with Deflation
have increased. This escalation results from lengthy loan terms, essential for
the continuation of general commercial activities and building of a country. In
fact, Deflation brings with it, a fall in the aggregate demand. Emergence of
deflationary spiral is considered to be one of the primary impacts of
Deflation. In this case, there is fall in the prices, resulting in the creation of a
vicious circle. This makes a problematic situation to worsen, rather than
reaching

any

amicable

solution.

Perhaps,

the

greatest

instance

of

deflationary spiral is the Great Depression, occurring in the United States of

America during the Civil War.
According to the Monetarist Theory of Deflation, Deflation affects an
economy by decreasing the velocity of money or the number of commercial
transactions more or less permanently. This leads to the emergence of a
remarkable contraction in the supply of money.