Both inflation and deflation affects the economy in different ways. Inflation is partial and unjust in its effects in the economy of a nation. This is because it redistributes income to favor the rich and leaves the poor masses, wage earners and consumers to suffer. It makes the rich people richer and the poor people poorer. As a result of its redistributive effects, inflation tends to increase the difference in income of people by increasing the gap between higher income group and lower income group. (See Inflation and Deflation by shweta mehra at essortment.com).
Also inflation affects the economy and people in a regressive way, the weak who cannot protect themselves from its effects are seriously affected. And mostly the middleclass bears the brunt. Furthermore, because of the unjust distribution effects of inflation, it changes the economic and social relationships of people. There will be different classes of people in the economy; the rich, the middle class and the poor. Rather than putting social equity into consideration, inflation takes wealth away from some people and gives it to other people. Consequently there will be a break in people’s morale. Also looking at the effects of inflation from its social ethics point of view it is demoralizing. It brings in the spirit of gambling and it promotes speculation thereby causing business skill and efficiency to be shifted to speculative purposes rather than productive purposes. Inflation eats dip into real savings due to the decrease in the value of money and it creates the wrong impression of prosperity because of its money illusion. (See Inflation and Deflation by shweta mehra at essortment.com).
On the other hand, deflation on its part is inexpedient. This is because deflation is falling in price level which consequently affects the marginal efficiency of capital adversely thereby reducing investment level which causes an increase in the level of unemployment. Deflation gives way for depression to enter an economy. In an economy facing depression, output goes down due to reduction in economic activities and scale of production and consequently investment shrinks.
Furthermore, due to the decrease in aggregate income, all the different classes in the society tend to be poor. Deflation brings mass unemployment into the economy. The level of employment contracts rapidly, financial income of people in the economy diminishes and therefore although the purchasing power of people is increased as a result of the fall in prices, they don’t buy goods in the required quantity. Therefore aggregate demand falls, resulting to fall in profits of businesses which will in turn result in looses by the producers forcing them to curtail investment and output more. This leads to further decline in employment and income.
For instance in the 1930s when price collapsed in the Western nations, unemployment soared with a quarter of the work force losing their job in most countries, economic activities crippled as banks collapsed and the few surviving ones refused to lend money. Deflation is so destructive to the economy because as prices keeps going down, businesses and individuals continue postponing their purchases hoping that prices will fall more and more thereby forcing demand to fall. And this affects the GDP. (See Essential Economics by Mathew Bishop)
More so, deflation creates a kind of bunker culture in an economy. Nobody will like to buy a $50,000 today when the price will go down to $20,000 by next year. When there is serious case of deflation in an economy, the economy will later come to a halt because nobody will buy goods that do not have value. That is goods that will lose their values quickly.
Deflation more disastrous than inflation
Deflation could be more disastrous to an economy than inflation because of the following reasons. First although inflation redistributes income and wealth in a partial and unjust manner to favor some people and disfavor others in an economy; it does not reduce the national income of an economy. The target of most countries is to keep inflation neither too low nor too high rather than having deflation which on the other hand reduces the national income of an economy, thereby making the masses generally poor. (See Inflation and Deflation by shweta mehra at essortment.com)
Secondly, deflation increases the level of unemployment in an economy, while inflation shows that all productive factors are employed in one way or the other. Inflation occurs when the level of full employment is reached while deflation is an under employment phenomenon which aggravates the problem of unemployment. (See inflation and deflation by shweta mehra at essortment.com).
Thirdly, inflation can easily be controlled using a clear monetary policy, accompanied by appropriate fiscal policies. On the other hand deflation is very difficult to handle and it is also difficult for an economy to recover from deflation. This is because once deflation hits an economy, people and businesses keep postponing their purchases, marginal efficiency of money capital diminishes and investment falls, consequently depression starts. And when depression starts monetary policy becomes of no help because there is no amount of increase in the supply of money in depression period that can impact positively on the price level, business expectations, capital and marginal efficiency of the economy. This can be seen in the great deflation of 1930’s, when American consumer prices fell by 25% and real GDP by 30 %.( "Essential Economics", by Matthew Bishop) But in an inflationary economy, appropriate application of monetary policy can be used in tackling inflation. (See Inflation and Deflation by shweta mehra at essortment.com)
In conclusion, deflation at first seems to be advantageous after all it increases the value of money. Every commodity in the economy becomes cheap and everybody seems to be rich creating an impression of a good quality of living. Yes deflation seems not to be bad after all. Think of a country where everything is cheap, amazing! However, there is more to deflation than it seems. Deflation is 100 times more disastrous than inflation; it attacks an economy like a virus. Once deflation sets in, it puts pessimistic tendency into the consumers, demand contracts and investment cripples, unemployment rises, and eventually the economy will come to a halt because of low consumption rate. On the other hand, during inflation demand tends to rise because consumers will buy more commodities thinking that prices will continue to rice. (See fig 1.0)
Graph interpretation
The graph in fig 1.0 shows the 20th century graph of deflation and inflation in USA Using consumer price index (CPI). The CPI is graphed in blue color on the left axis while the right axis is showing the annual rate of change in the CPI either positive or negative, and it is marked in red. In inflation period, general prices are rising and that is indicated by a positive YoY change, the red line goes above zero line. The zero line is indicated by the tick gray line at 0%. When there is deflation, the red line goes below the zero line, that is change in YoY becomes negative. Inflation occurred more than inflation as shown in the graph. It was only during the great depression of 1930’s that America experienced great deflation. This graph shows exactly how disastrous deflation can be to an economy (From inflation or deflation 2 by Adam Hamilton at zealllc.com).
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