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Critical Analysis of Deflation

By Ajay Jaiswal

Edited by Namrata Caleb

People accept inflation as a fact of life. But nowadays the opposite phenomenon, called deflation, is happening.

Deflation is a decrease in the general price level of goods and services. One may consider deflation as a good thing, considering the fact that you have to pay less, but in fact it is not. Rather deflation shows that the economy is deteriorating.

Deflation is generally associated with significant unemployment, which is only corrected after wages drop considerably. Furthermore, businesses’ profits also drop significantly during periods of deflation, making it difficult to raise additional capital to expand and develop new technologies.

“Deflation” is usually confused with “disinflation.” While deflation represents a decrease in the prices of goods and services throughout the economy, disinflation represents a situation where inflation increases at a slower rate. Deflation is a rare phenomenon that does not occur in the course of a normal economic cycle, and hence, investors must recognize it as a sign that something is severely wrong with the state of the economy.

Nowadays deflation is the greatest concern in the world economy. While in developing countries like Nigeria, South Africa and India where Central Banks are taking measures to control Inflation, Central Banks in developed countries are pushing for persistent inflation.  From an era of controlling inflation to present where central banks in developed economies are struggling to generate even an inflation rate of 2 %, it has become tough for them to control the economy from the risks of deflation and further recession .

In countries like US and Britain inflation is below Central Bank’s target where and they can’t do much to it because their interest rate is already at lower positions, I.e., 0.5 % . Inflation Rate and Interest Rate have an inverse relation. An increase in interest rate would further lead to lower inflation, decrease in interest rate would increase it. However in case of developed economies where interest rate is already low, increasing interest rate would further act as a catalyst to stop inflation.

Whereas in developing countries like India, Central Bank is setting a target which is most of the time unachievable,  leaving past 3-4 months, thanks to fall in oil prices which has come down to a four year low. Even though being forced by Government at the centre and Indian Inc., RBI’s tough stand on interest has been acknowledged by the world economic leaders as RR Rajan gets the best governor award for his tough stand against Inflation.

Coming back to developed economies, low inflation is now no more a phenomenon but a consistent cycle. The inflation being consistently low for past few years propelled consumers to buy goods in future as goods bought will become cheaper tomorrow, thus choking consumption and also the money made tomorrow will be worth less than money today, choking investment , forcing central banks for a monetary expansion as we had in US and Japan. The US economy is back to 2-3 % growth rate, though things are not guaranteed here. But, in the case of Japan where they were providing stimulus something  went wrong from nowhere because their economy contracted by 1.6 % leading its economy back to recession.

Our monetary expansion or stimulus provided by Central Banks sometimes may be an appropriate solution to deflation while it may actually be worse as in case of Japan.

So basically India’s future prospects are bright and it has no reason to worry for a high inflation rate. Recalling Raghu Ram Rajan’s comment on Indian economy, keeping interest rate high would further lead to Sustainable Economic Growth. “Developing countries understand that very well .It is something that

Mauritius is trying to do, it is also something that India is trying to do. It

is something that even the developed world has to realise it has to do.”

Ajay Jaiswal is currently in his second year at college, pursuing a Bachelor of Arts degree in Economics (Hons) at Sri Ram College of Commerce, University of Delhi. Originally from Bokaro Steel City, Jharkhand. He is aspiring to be an IAS officer in the future. His interests lie in the area of Mathematics, Indian Economy and Global markets. He spends his time watching movies or reading.