Is deflation bad ?

Ashok TJ (21)
Dakshinamurthy M (29)
Manicka Veena (59)
 DEFINITION
• In simple words, deflation can be termed as a
fall in the general price level.

It is a decline in general price

levels, often caused by reduction
in supply of money or credit.
It can be brought about by
reduction in government spending,
personal spending, investment
spending.
There are four causes for Deflation. 

• Decreasing Money Supply

• Increasing Supply of Goods
• Decreasing Demand for Goods
• Increasing Demand for Money

Effects of deflation on the economy

A fall in the price of goods and services increases the

purchasing power of the people. This might present a positive
picture in the short run. However, if this effect extends, it
leads to deflation, adversely impacting the economy.
 Effects of Deflation on the economy
• The impacts or effects of deflation are

• There is a fall in the general price level.

• The producers incur losses.

• There is a fall in the level of production as there are unsold

stock of goods.

• Fall in the level of national income.

• Fall in the level of employment.

• Sustained deflation will lead to deflationary spiral

Deflation can emerge for two very different reasons:

(1) a surge in aggregate supply (Good Deflation).

(2)a collapse in aggregate demand(Bad Deflation)

Good Deflation:

Productivity gains help producers to share their growing wealth with

consumers in the form of lower prices, perhaps in an attempt to expand the
overall size of their market or to meet competitive challenges.

Eg: Technology gain and economies of scale achieved in electronics and

computer industry has lowered the prices of such products.
Bad Deflation:

However, if deflation is caused by a decreasing supply of money the great

depression, that would be bad. The stock market crash sucked all the
liquidity out of the market place, the economy contracted, people lost
their jobs and then banks stopped loaning money because people were
defaulting. The problem compounded as more people lost their jobs and
money supply fell further causing more people to lose their jobs, etc.

Eg: Great Depression in the U.S. was in the 1930s, Between 1929 and 1933,
prices fell on average by 15 percent. This deflation was driven by a decline
in output, demand, and credit—too little money and wages chasing too many
goods and workers.
 MEASURES TO CORRECT
DEFLATION

QUANTATIVE INSTRUMENTS
QUALITATIVE
INSTRUMENTS
Bank Rate Policy
Publicity
Open Market
Operations Moral Suasion
 QUANTATIVE INSTRUMENTS

1) Changes in Bank Rate Policy or Rediscount Rate:

To remove deflation central bank will decrease the bank rate, the commercial
banks will also decrease the rate loans. In this way, people will get more loans.
Investment production, employment and Prices will start rising up. Accordingly,
deflation will be controlled.

2) Open Market Operation

This is the second instrument of the monetary policy. If there is deflation in the
economy. To control the deflation, the central bank purchases the government
securities. Then the monetary base of the commercial banks will increase their
loaning power will increase. As a result, investment will increase, income and
prices will go up.

3) Changes in Reserve Requirements

In case of deflation, the central bank reduces the reserve requirements, the
commercial banks will be able to advance' more loans. Hence, deflation could
be removed.
4) Changes in Reserve Capital
Each commercial bank has to keep a certain ratio of its deposit with central
bank. In case of Pakistan, each commercial bank has to keep 5% of its deposit
in the central bank. By changing the reserve capital, a central bank can control
the supply of money by commercial banks.
On the other hand, if central bank decreases the 'reserve ratio, the
commercial banks will be having more funds to advance. Accordingly, the
deflation could be controlled.

5) Changes in Marginal Requirements

Commercial banks do not give loans against leaves, rather they ask for pledges
to make. How much a person will have to pledge is settled by the central bank.
This is given the name of marginal requirement. The central bank can bring
changes in the marginal requirements. During deflation the marginal
requirements are decreased. Hence people will get more loans from the
commercial banks. As a result supply of money will go up and deflation will be
controlled.
 Qualitative Methods

• Moral Suasion: It is concerned with just as a moral request by central

bank to commercial banks to provide more loans at cheaper rate to
control deflation.

• Publicity: The central bank of the country is the overall in charge of

economic stability of the country. Its aim is to protect the economy
from inflation and deflation. For this purpose, it analyses the whole
economy. It keeps an eye over the activities of the commercial banks.
If the commercial banks are found advancing loans which create
inflation or deflation, their activities will be unhealthy for whole
economy. The central bank can black list such banks. Thus to avoid
such bad reputation in' future, they will be careful in advancing loans.
 Deflation in Japan- Bad Deflation
• Deflation in Japan started in the early 1990s.
• On March 19, 2001, the Bank of Japan and the Japanese
government tried to eliminate deflation in the economy by
reducing interest rates .
• Despite having interest rates down near zero for a long period
of time, this strategy did not succeed.
• Some economists, such as Paul Krugman and some Japanese
politicians spoke of deliberately causing inflation.
•  In July 2006, the zero-rate policy was ended.
• In 2008, the Japanese Central Bank still has the lowest interest
rates in the developed world, deflation has still not been
eliminated and the Nikkei 225 fell approximately 50%
(between June 2007 and December 2008).
 Deflationary Spiral in Japan
Tax, insurance
premiums, medical
costs recently up Less expense

Less disposable income Less sales

Bursting “Bubble” in 1991 More Intensive retail
Stock market slump in 2001 competition during
late 1990s
Less assets value
Lower Price
Less income

Lowering base wage,

life-time employment More cost cuts
collapsed, increasing no. More shift to China
of layoff after 2000s during late 1990s
 Deflation in Japan
• Japan is again haunted by deflation.
• The prices of consumer goods are falling and households are
tightening their purse strings. Concurrently, companies are
holding back investment and trying to cut costs to remain
competitive.
• Last November the Japanese government acknowledged the
resurgence of the country’s deflation problem and passed on
the buck to the Bank of Japan and pressured it to do something
about it. 
• It injected up to 10 trillion yen in three-months loans to
commercial banks at a rate of 0.1 per cent.. In March, the BOJ
responded to further government pressure by increasing the
programme to 20 trillion yen.
 Reasons for deflation in Japan
• Fallen asset prices: There was a large price bubble in
both equities and real estate in Japan in the 1980s (peaking in
late 1989).

• Insolvent companies

• Insolvent banks

• Fear of insolvent banks

Thank You