Readers Question: Define deflation discuss its merits and demerits?
Deflation is defined as a fall in the general price level. It is a negative rate of inflation. It means the value of money increases rather than decreases.
In the twentieth century, periods of deflation have been rare. Generally, western economies have experienced inflation. The most significant period of deflation was in the 1920s and 1930s. These decades (especially, the 1930s) were characterised by economic depression. Therefore, deflation is often considered to be very damaging.
There is an essay here about the economic costs of deflation
Despite the many serious costs of deflation. The ‘right kind of deflation’ could be beneficial. The right kind of deflation involves lower prices through increased productivity and better technology. A Level students should think of the AS curve shifting to the right – which both lowers the price level and increases real GDP.
Although deflation in the twentieth century is often associated with economic recession. In the nineteenth century, deflation was compatible with economic growth.
2 comments ↓
I think it important to distinguish general price level increases (decreases) and inflation (deflation) . Increase in RPI/CPI consequent on (say) large oil price rise are not inflation per se. They may start an inflationary process as people try to maintain real income through pay rise to match price rises. However, if we (the UK) as a whole must pay more for oil then we, on average, must be worse off. Accepting the higher prices without asking for more pay achieves the UNAVOIDABLE reduction in living standards without the risk of inflation. It is the risk of inflation that causes the Bank to either raise or hold up interest rates in face of the negative supply shock of imported cost increases (which is already tending to push the economy towards slow down/recession).
[...] There are also other problems of deflation. [...]
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