WHAT IS DEFLATION, ITS EFFECTS AND HOW TO CONTROL DEFLATION What is 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 f money rises during deflations. A given sum of money and purchase more goods and services. It should be noted that deflation is the opposite of inflation.

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Causes of Deflation

  • Increase in production: Increase in production of goods without corresponding increase in the volume of money in circulation can lead to deflation.
  • Increase in taxation: When taxation is increased, it will definitely reduce the volume of money in circulation, thereby causing deflations to occur.

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Effects of Deflation on an economy

  •  Decline in profits: Deflation causes a decline in profits as a result of low volume of money in circulation.
  •  It results in unemployment: Deflation brings about unemployment in the labour market.
  • 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.
  •  Reduction in investment: As a result of low savings, the level of investments tends to be reduced.
  •  Creditors gain: Creditors gain because money has added value during the period of deflations.
  •  It encourages exports: Goods that are to be exported are generally very cheap during deflation.
  • 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.
  • Fixed income earners gain: During the period of deflations, fixed income earners gain because wages are fixed and they are able to buy more goods and services.
  •  Increase in value of money: There is increase in the value of money due to the fact that its supply is lower than its demand.
  • It encourages savings: Savings is encouraged because the value of money increases during deflations.
  • Reduction in taxation: This practice enables people to have more money, thereby increasing their purchasing power and controlling deflation.
  • Use of deficit budgeting: An increase in government expenditure helps to inject more money into circulation by curbing the effects of deflation.
  • Reduction in bank rate: This will assist investors to borrow more money from banks, thereby increasing the volume of money in circulation.
  • Increase in wages and salaries:        This will help to inject more money into circulation, thereby controlling deflation.
  • Use of open market operation: The Central Bank does this by purchasing securities from commercial banks. 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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