Inflation occurs when the price of goods and services in a country rises, whereas deflation occurs when the price of goods and services falls. Inflation and deflation can be seen as the opposite sides of the same coin.
It is critical to maintain a balance between these two economic circumstances, namely inflation and deflation, because the economy may swiftly swing from one to the other as a result of these two conditions. By executing monetary policy, such as establishing interest rates in India, the Reserve Bank of India keeps an eye on price movements and manages deflation or inflation.
The rate at which the price of goods and services rises is referred to as inflation. Consumer purchasing power is frequently impacted by inflation. Most central banks strive to keep inflation under control in order to keep their economies running smoothly. Inflation has both advantages and downsides.
Inflation is defined as a rise in the price of everyday goods and services such as food, housing, clothes, transportation, recreation, consumer staples, and so on. The average price change in a basket of commodities and services over a period of time is used to calculate inflation.
In India, the Ministry of Statistics and Programme Implementation calculates inflation.
Inflation is produced by a variety of variables, including the following:
1) Money Supply
One of the key causes of inflation is an economy’s excess currency (money) supply. This occurs when a country’s money supply/circulation expands faster than its economic growth, lowering the currency’s value.
Countries have moved away from conventional methods of valuing money based on the quantity of gold they own in the contemporary period. The amount of money in circulation determines modern techniques of money valuation, which is subsequently followed by the public’s view of that currency’s value.
2) National Debt
National debt is influenced by a number of factors, including a country’s borrowing and expenditure. In the event that a country’s debt level rises, the country has two options:
a) Taxes can be raised internally.
b) To pay off the debt, more money can be produced.
According to the demand-pull effect, when wages rise in a rising economy, individuals will have more money to spend on products and services. As demand for products and services rises, firms will raise prices, which will be passed on to customers in order to balance supply and demand.
4) Cost-Push Effect
This theory asserts that when corporations confront higher input costs for raw materials and labor while producing consumer goods, they will maintain their profitability by passing on the higher production costs to the end customer in the form of higher pricing.
5) Exchange Rates
When a country’s economy is exposed to global markets, it operates primarily on the basis of the dollar’s value. Exchange rates are an essential component in influencing the pace of inflation in a global trade economy.
Effects of Inflation
When a country experiences inflation, the people’s buying power declines as the cost of goods and services rises. The value of the currency unit falls, lowering the country’s cost of living. When the rate of inflation is high, the cost of living rises as well, causing economic growth to slow down.
A healthy inflation rate of 2% to 3%, on the other hand, is regarded as favorable since it immediately leads to higher salaries and corporate profitability, as well as keeping capital moving in a rising economy.
Deflation is the broad term for a drop in the price of goods and services when the rate of inflation falls below 0%. If and when an economy’s money supply is restricted, deflation will occur organically. Deflation in an economy means that things are becoming worse.
Deflation is usually associated with high unemployment and low levels of production in products and services. The terms “deflation” and “disinflation” are frequently interchanged. While deflation refers to a drop in the price of goods and services in an economy, disinflation occurs when inflation rises more slowly.
Causes of Deflation
Deflation can be produced by a variety of reasons, including:
a) Structural changes in capital markets
When firms providing identical goods or services compete, they often cut their prices to gain a competitive advantage.
b) Increased productivity
Increased production efficiency, as a result of innovation and technology, leads to lower pricing for goods and services. Some inventions have an influence on the productivity of specific industries as well as the overall economy.
c) Decrease in the supply of currency
The drop in money supply will lower the prices of goods and services, making them more accessible to the general public.
Effects of Deflation
The following are some of the effects of deflation on an economy:
1)Reduction in Business Revenues
In an economy faced with deflation, businesses must drastically reduce the prices of their products or services to stay profitable. Revenues begin to decline when prices are reduced.
2) Lowered Wages and Layoffs
When sales start to decline, firms must find ways to cut costs in order to reach their goals. One method is to reduce pay and layoffs. This has a negative impact on the economy since customers will have less money to spend.
Inflation and Deflation: What Do They Mean to You?
If your income does not keep up with growing prices, inflation decreases your quality of life. Most of the time, it doesn’t. However, if inflation is about 2%, consumers will buy now before prices rise in the future. This has the potential to boost economic growth. Inflation affects your life regardless of how minor it is.
It’s possible that deflation will cost you your job. Your employer may not be able to stay profitable if prices continue to fall. Layoffs may be necessary to continue in business. Many individuals will lose their employment if deflation continues for a long time. Companies fall out of business when the economy slows.