Assignment on

Causes of Deflation

Dhaka International University

Department: BBA
Course Id CBC: 214
Course Name : Macroeconomics
Submitted to: Ms. Tarana Tabassum
(Department Of Business Administration/Assistant Professor)

Name Roll Batch

Md. Musfiqur Rahman 08 63
 Causes of Deflation

Deflation: Deflation is a general decline in prices for goods and services,

typically associated with a contraction in the supply of money and credit
in the economy. During deflation, the purchasing power of currency rises
over time.
Deflation usually occurs during a deep recession, when there is a sustained
fall in demand and output. This deflation may occur in the aftermath of
credit boom and bust or severe tightening of monetary policy/fiscal
policy. Monetarists emphasize the role of the money supply – falling
money supply and/or falling velocity of circulation causing a fall in the
price level.

Causes of Deflation
Economists determine the two major causes of deflation in an economy
as-
1. Fall in aggregate demand and
2. Increase in aggregate supply.

Fall in the money supply

When the supply of money and credit falls, without a corresponding
decrease in economic output, then the prices of all goods tend to fall.
Periods of deflation most commonly occur after long periods of artificial
monetary expansion. The major contributor to this deflationary period
was the fall in the money supply following catastrophic bank failures.
Decline in aggregate demand
A decline in aggregate demand typically results in subsequent lower
prices. Causes of this shift include reduced government spending, stock
market failure, consumer desire to increase savings, and tightening
monetary policies (higher interest rates).

Deflation spiral
Deflation can become a self-reinforcing loop. Falling prices create
circumstances for prices to continue falling. With falling prices – firms
want to cut wages – lower wages lead to less spending (AD) and lower
costs. Falling prices lead to a decline in confidence, and therefore lower
spending and lower investment.

Technological advances
Advances in technology or rapid application of new technologies in
production can cause an increase in aggregate supply. Technological
advances will allow producers to lower costs. Thus, the prices of products
will likely go down.

Increase in unemployment
During deflation, the unemployment rate will rise. Since price levels are
decreasing, producers tend to cut their costs by laying off their employees.

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