DEFLATION :-

Deflation is a decrease in the general price of goods and services.

It occurs when the inflation rate falls below 0%(a negative inflation rate).
Deflation increases the value of currency over time.
It is different from disinflation in a sense that disinflation is a slow down in the
inflation rate i.e. when inflation declines to a lower rate but is still positive.
Deflation is generally regarded negatively and it is more dangerous than
inflation, because of deflationary spiral which is a downward price reaction
to an economic crisis (recession and depression) leading to lower production,
lower wages, lower demand and still lower prices.
CAUSES OF DEFLATION :-
 Decrease in money flow.
Increased Bank Rate.
Fall in aggregate demand.
 Increase in aggregate supply.
The fall in aggregate demand triggers the decline in the prices of goods and services. Some
factors leading to a decline in aggregate demand are:
Fall in the money supply
A central bank may use a tighter monetary policy by increasing interest rates. Thus,
people, instead of spending their money immediately, will prefer to save them. In addition,
increasing interest rates will lead to higher borrowing costs, which will also discourage
spending in the economy.
Decline in confidence of people to spend their money.
The increase in aggregate supply will lead to an oversupply of goods in the
economy. Subsequently, producers will face fiercer competition and will be forced to
lower prices. The growth in aggregate supply can be caused by following factors :-
Lower production costs
A decline in price for key production inputs (e.g., oil) will lower production costs.
Producers will be able to increase production output, which will lead to an
oversupply in the economy. While demand will remain unchanged, producers will
need to lower their prices on goods to keep people to buy their goods.
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.
Counteraction against Deflation
Until 1930s it was commonly believed by economists that deflation would cure
itself i.e. as prices decreased, demand would naturally increase .
This view was challenged in 1930s during the Great Depression by the
economist John Maynard Keynes .
The Keynesian theory states that government and central banks had to take
active measures to boost demand through tax cuts or increase in govt. spending
or deflation will give rise to unemployment.
Today to counter deflation, the RBI can use monetary policy to increase the
money supply and deliberately induce price rise .
Rising prices are essential for any sustained recovery because more business
means increased profits and better investment, more production and more
employment .