January 2012

Why deflation can be equally if not more harmful than inflation?

Money, Deflation, Inflation, Economy, GDP, Crisis, Current Account Deficit, Money Supply , Interest Rates

Deflation happens when there is a decrease in the general prices. The prices can be of goods and services. This is exactly the opposite of what happens in inflation. In case of inflation there is a general increase in the prices. The value of money reduces in inflation and the value of money increases in case of deflation. This means that with the same amount of money, you can buy more goods and services at later period of time due to decrease in the prices.

Deflation can happen when there is reduction in spending either by government, personal spending or investment spending. It can happen when either of the following happens :

  1. Decrease in Money Supply
  2. Increase in supply of Goods or services
  3. Decrease in demand for goods or services
  4. Increase in demand for money

On the surface it appears that increase in value of money is a good thing. In fact it is good for those who are holding cash or for those who are creditors.