In this article we will highlight the Universal Causes Of Deflation. Deflation refers to a decrease in the general price level of goods and services in an economy over a period of time, which results in an increase in the real value of money. It is the opposite of inflation, which is the rate at which the general level of prices for goods and services is rising and, subsequently, purchasing power is falling. Deflation can be caused by a combination of various factors, including.
You Must Know The Universal Causes Of Deflation For understanding The Economic Condition:
Causes of Deflation
The process of deflation is opposite of inflationary process. Following are major causes of deflation.
Decrease in Supply of money
When central bank of a country reduces the supply of money, it may causes a decrease in general * price level or deflation in the economy
When production of goods and services in the economy is more than the aggregate demand, then a large portion of goods and services is not sold. This situation cause a decrease in general price and hence deflation in the economy.
If there is illegal inflow of foreign good in the economy, it definitely causes the prices of local goods to fall. Thus smuggling is also a cause of deflation in the economy.
When an economy faces the problem of high unemployment then there is low purchasing power in the economy. Due to insufficient demand the general price level falls.
When people in economy start saving more to some social or economic change, this eventually causes deficiency of aggregate demand in the economy. Due to fall in aggregate demand prices level and national income also fall in the economy.
Fall in Investment
According to Keynes Investment is determined together by market rate of interest and MEC. The MEC or expected rate of profit depends upon sop many economic, social and political factors. If MEC falls in the economy then investment also falls and this results in decrease of general price level in the economy.
Sometimes economic conditions of an economy change such that circulation of money falls very fast. The availability of credit to business reduces to some minimum level. Due to these circumstances, volume of business also shrinks and price level falls.
There are many other economic and non economic causes of deflation. For example deflationary process is initiated when the level of money Income falls relative to the current supply of goods and services. Another cause of deflation may be disequilibrium in the balance of payments. Sometimes tight monetary policy causes a sharp rise in the rate of interest which results increase in investment and fall in prices and output.
- Decreased Demand for Goods and Services (Demand-Pull Deflation): This can be due to factors like reduced consumer spending, high-interest rates, or increased savings. When consumers and businesses cut back on spending, it can lead to a surplus of goods and services in the market, causing prices to drop.
- Increase in Supply (Supply-Side Deflation): If there’s an increase in the supply of goods and services without a corresponding increase in demand, prices can decrease. This can be due to technological advancements, increased productivity, or the introduction of cheaper imports.
- Tight Monetary Policy: Central banks can influence deflation by reducing the supply of money and credit in the economy. By raising interest rates or selling government bonds, central banks can reduce the amount of money circulating in the economy, leading to decreased demand and thus lower prices.
- High Levels of Debt: If businesses and consumers have high levels of debt, they might cut back on spending to service that debt. This reduced spending can lead to decreased demand and deflation.
- Banking and Financial Crises: During financial crises, banks may become reluctant to lend money, leading to reduced credit availability. This can depress economic activity and lead to deflation.
- Structural Changes in the Economy: Shifts in industries or major economic sectors can lead to deflation if they result in increased productivity and reduced costs without a corresponding increase in demand. For instance, technological advancements in the production of goods can lead to decreased prices.
- Globalization: The integration of global markets can lead to deflationary pressures as businesses source cheaper inputs from around the world and competition intensifies.
- Falling Costs of Raw Materials: If the costs of raw materials like oil, metals, and agricultural products fall substantially, it can lead to reduced production costs and lower consumer prices.
- High Levels of Uncertainty: Economic, political, or financial uncertainties can lead businesses and consumers to delay spending, leading to deflation.
- Psychological Factors: Expectations of future deflation can become self-fulfilling. If consumers and businesses expect prices to fall in the future, they might delay purchases or investments, leading to decreased demand and actual deflation.
Deflation can have negative consequences for an economy. While it increases the real value of money and can benefit savers, it can also lead to reduced consumption, increased debt burdens in real terms, and potentially result in a deflationary spiral where the economy can stagnate for extended periods.