- Define deflation
- State the causes of deflation
- State the effects of deflation;
- Identify the control measures use during deflation.
Deflation may be defined as a continuous fall in the price level of goods and services as a result of decrease in the volume of money in circulation. Since prices fall, the value of money rises during deflation. A given sum of money can purchase more goods and services. It should be noted that deflation is the opposite of inflation.
Causes of Deflation
i. Budget surplus: Budget surplus serves as a device by which the rate of injecting money into circulation was reduced.
ii. Increase in bank rate: This serves to discourage commercial banks from borrowing from the Central Bank and by so doing reduces the banks’ ability to lend money, leading to a reduction in the volume in circulation.
iii. Increase in production: Increase in production of goods without corresponding Increase in the volume of money in circulation can lead to deflation.
iv. Increase in taxation: When taxation is increased, it will definitely reduce the volume of money in circulation thereby causing deflation to occur.
Effects of Deflation
i. Decline in profits: Deflation causes a decline in profits as a result of low volume of money in circulation.
ii. It results in unemployment: Deflation brings about unemployment in the labour market.
iii. Fall in prices of goods: As a result of decline in the volume of money in circulation, the prices of goods and services tend to fall.
iv. Reduction in investment: As a result of low savings, the level of investment tends to be reduced.
v. Creditors gain: Creditors gain because money has added value during the period of deflation.
vi. It encourages exports: Goods that are to be expected are generally very cheap during deflation.
vii. It discourages imports: Goods imported are generally more expensive and there is no hope of selling such goods in an economy that is experiencing deflation.
viii. It encourages savings: Savings is encouraged because the value of money increases during deflation.
Control of Deflation
i. Reduction in taxation: This practice enables people to have more money thereby increasing their purchasing power and controlling deflation.
ii. Use of deficit budgeting: An increase in government expenditure helps to inject more money into circulation by curbing the effects of deflation.
iii. Reduction in bank rate: This will assist investors to borrow more money from banks thereby increasing the volume of money in circulation.
iv. Increase in wages and salaries: This will help to inject more money into circulation thereby controlling deflation.
v. Use of open market operation: The Central Bank does this by purchasing securities from commercial bank. This makes it possible for the commercial banks to be able to lend money out and increase the volume of money in circulation.
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- Define deflation
- What are the causes of deflation?
- What are the effects of deflation?
- State the control measures used during deflation.
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