Deflation Situation

Deflation Situation

Deflation, a situation in which the value of the monetary unit is rising as a result of falling prices. In theory, the value of money may fall as a result of increased productivity if money incomes rise less than proportionately. Supply would then exceed demand, and prices would have to fall if the amount of goods and services bought was to be equal to the amount available for sale. In practice, deflation is a situation in which falling total monetary demand is causing reduction in the output of goods and services, in the demand for factors of production, in money incomes and in the general price level There can be several reasons for a fall in monetary spending or outlay. Initially the fall in demand may be internal or external Government expenditure may be reduced, or the level of private consumption expenditure may fall, or the business world may reduce its investment expenditure. Overseas demand for a country's exports may decline. Whatever the reason, reduced expenditure means unsold goods and the accumulation of unwanted stocks. If the reduction in demand persists, output will be reduced, .unemploymentMU rise, and wages and prices will fall.

An important contributory factor in the extent of deflation and the rate of growth of depression is the psychological. Once optimism is replaced by pessimism, entrepreneurs plan for reduced output, fears spread and tend to produce the state that is feared. When there is a general fear of falling incomes, there is a tendency to be cautious and to reduce expenditure. Moreover when prices are expected to fail, there is an increased demand for liquidity in the form of money, in the hope of buying later when prices will be lower. As with inflation, deflation tends to be cumulative, and monetary demand may continue to fall until an 'external' event provides an impetus to recovery, the central government reflates the economy or stocks and capital equipment are run down to the point at which replacement is needed to sustain even the low slump level of production and thus provides an 'internal' impetus to recovery.

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