Deflation & Disinflation
Notes
Deflation is a sustained fall in the general price level (a negative inflation rate). Disinflation is a fall in the rate of inflation: prices are still rising, but more slowly (for example, inflation falling from 8% to 4%).
Causes of deflation: weak aggregate demand, excess capacity and oversupply, tight money and credit, falling asset prices, productivity gains, and a strong currency.
Effects of deflation
- Consumers postpone purchases expecting lower prices, so demand falls further; profits and wages fall; unemployment rises.
- Debt deflation (Irving Fisher): the real burden of debt rises, causing defaults and bank stress.
- Monetary policy loses power at the zero lower bound (a liquidity trap).
- Examples: the Great Depression (1930s); Japan's "lost decades" from the 1990s. In India, WPI inflation turned negative at times (for example, in 2015-16 and 2023).
Policy response: monetary easing (lower rates, quantitative easing) and fiscal stimulus; reflation.
Basis | Inflation | Disinflation | Deflation |
|---|---|---|---|
Price level | Rising | Rising more slowly | Falling |
Inflation rate | Positive | Positive but declining | Negative |
Example | 6% to 7% | 8% to 4% | -1% |
Related terms: reflation (raising prices after deflation); stagflation; hyperinflation; inflationary gap (demand above potential output) vs deflationary gap (demand below potential).
Key Points
- Deflation: a falling price level (negative inflation).
- Disinflation: a falling inflation rate; prices still rise.
- Deflation causes debt deflation, a fall in demand and unemployment.
- Japan's lost decades are a classic example.
- Reflation aims to reverse deflation.
MCQs
Q1. A fall in the rate of inflation, with prices still rising, is called:
(a) Deflation
(b) Disinflation
(c) Reflation
(d) Stagflation
Ans: (b) .
Q2. Debt deflation was explained by:
(a) J.M. Keynes
(b) Irving Fisher
(c) Milton Friedman
(d) Adam Smith
Ans: (b) .
Q3. Deflation me
Ans: (a) Falling inflation rate
(b) A sustained fall in the general price level
(c) A fall in output
(d) A rise in unemployment only
Ans: (b) .