Deflation is defined as continuous or sustained fall in the general price level of goods and services in the economy. Deflation is the opposite of inflation. When the prices of all the goods and services decreases the value of money or purchasing power of money increases, and it causes inflation. Deflation is caused when there is excess supply of goods and services over limited demand and when the cost of production (rent, wage, interest, and price of raw materials) decreases.
Causes of Deflation:
1. Rapid increase in industrial and agricultural production:
If there is an increase in agricultural and industrial production, there will be more supply of goods and services in the economy. It reduces the price level that is deflation takes place.
2. Decrease in wages and salary:
When there is decrease in wages and salaries of the workers, it reduces the purchasing power of the consumers in the economy. It reduces the aggregate demand and the suppliers reduce the prices of all goods and services to increase sales.
3. Control of credit by the central bank:
Control of credit by central bank directly affects the flow of money, business activities, and consumer’s purchasing power in the nation. When central bank controls the credits, it also causes deflation.
4. Decrease in money supply by central government:
When less money is supplied in the economy, everybody gets less amount of money with them. The purchasing power of consumers decreases. So, the producers reduce the prices of goods and services, and deflation takes place.
- Producers are discouraged to increase production due to fall in the price of goods and services.
- It may affect the rate of capital formation.
- The fall in wages and salary in long-term reduces the living standard of people.