Deflation

S.Arul Vignesh (PSG IM)

“money which is a source of so many
blessings to man kind, becomes also a
source of peril and confusion unless we
control it”

“Inflation is unjust & deflation is

inexpedient”
What is deflation ?
Decrease in the general price level of goods and
services

- An annual inflation rate below zero percent (a

negative inflation rate), resulting in an increase in the
real value of money – allowing one to buy more goods
with the same amount of money.

Deflation increases the real value of money

 Causes of deflation
 Deflation may be caused by a combination of the supply
and demand for goods and the supply and demand for
money, specifically the supply of money going down and
the supply of goods going up.

 Historic episodes of deflation have often been associated

with the supply of goods going up (due to increased
productivity) without an increase in the supply of money,
or (as with the Great Depression and possibly Japan in the
early 1990s) the demand for goods going down combined
with a decrease in the money supply.
Problems due to deflation ..
Reduction in aggregate demand
Deflationary spiral
Liquidity trap
Often is related with recessions
Reduction in velocity of money
Effects of deflation
Decreasing nominal prices for goods and services.
Cash money and all monetary items increase in real
value over time.
Discourages bank savings and decreases investment.
Enriches creditors at the expenses of debtors.
Benefits fixed income earners.
Associated with recessions and unemployment.
Types of deflation
Growth deflation.
Cash building (hoarding) deflation

On the supply side:

Bank credit deflation

Money supply side type deflation

Credit deflation
Effects of scarcity of 'official' money
Counteracting deflation
Until the 1930s, it was commonly believed by economists
that deflation would cure itself.
boost demand through tax cuts or increases in
government spending.
Reserve requirements from the central bank were high
compared to recent times. So were it not for redemption
of currency for gold (in accordance with the gold
standard), the central bank could have effectively
increased money supply by simply reducing the reserve
requirements and through open market operations (e.g.,
buying treasury bonds for cash)
Deflation in Japan
started in the early 1990s
Fallen asset prices
Insolvent banks
Insolvent companies:
Imported deflation
Fear of insolvent banks:
Japanese style deflation
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