How can deflation Interval be controlled ?
Answers
Answer:
Deflation is the opposite of inflation. Just as inflation is a phenomenon of rising prices, deflation is a phenomenon of falling prices. In the words of Crowther, “Deflation is that state of the economy where the value of money is rising or the prices are falling.” No doubt deflation is associated with falling prices, but it is not that each and every fall in price will be termed as deflation.
Only those falls in prices which result in unemployment, overproduction and fall in the economic activity are deflationary. In short, deflation is a situation in which falling prices are accompanied by falling levels of employment, output and income
Causes of Deflation:
Deflation is a situation in which falling prices are accompanied by falling levels of employment, income and output. Deflation may be due to certain natural causes, or it may be due to a deliberate policy of the government.
The following are the important causes of deflation:
1. Keynes’ Explanation
Keynes had developed a systematic theory to explain the causes of deflation (or depression).
(i) Deficient Aggregate Demand:
The main reason for deflation is the deficiency of aggregate demand which leads to over-production and unemployment. Aggregate demand consists of aggregate consumption expenditure and aggregate investment expenditure.
(ii) Less Investment Expenditure:
Private investment is governed by marginal efficiency of capital (MEC) and rate of interest. Deflation is the result of decline in investment which is due to (a) low MEC or low profitability of capital and (b) high rate of interest.
(iii) Fall in MEC:
As the process of economic expansion goes on, certain forces come into operation which exerts downward pressures on MEC.
These forces are:
(a) During the process of expansion costs of production start rising on account of the increasing scarcities of materials and equipment. Wage cost also rises because of scarcity of labour. Rising costs have the depressing effect on MEC.
(b) Increasing abundance of output resulting from industrial expansion leads to lessen the returns below expectations which also depress MEC.
(iv) Less Consumption:
The basic cause of deflation or depression lies in Keynes’ concept of consumption function or his psychological law of consumption. According to this law, the consumers do not spend the whole of the increment of their incomes on consumer goods.
As the income increases, the community spends a smaller proportion of its increased income on consumer goods. The reduced sale of consumer goods leads to the accumulation of stock of consumer goods (or overproduction). This also has adverse effect on business expectations and MEC.