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.
Causes of Deflation
- Budget surplus: Budget surplus serves as a device by which the rate of injecting
money into circulation was reduced.
- Increase in bank rate: This serves to discourage commercial banks from borrowing from the Central Bank and by so doing reduces the banks’ ability to lend money, leading to a reduction in the volume in circulation.
- 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.
HOW TO CONTROL OF DEFLATION
- 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.