Deflation & Stagflation – Meaning & Economic Consequences
Besides inflation, economies may also face deflation and stagflation.
1. Deflation – Meaning
Deflation is a sustained fall in the general price level of goods and services over a period of time.
Features:
- Falling prices.
- Often associated with low demand, low output, high unemployment.
2. Consequences of Deflation
- Consumers may postpone purchases, expecting lower prices.
- Firms face falling profits, may cut production and employment.
- Real burden of debt increases (loans become costlier in real terms).
- Can lead to deflationary spiral if not checked.
3. Stagflation – Meaning
Stagflation = Stagnation + Inflation – a situation of high inflation together with high unemployment and stagnant output.
It is more difficult to handle than simple inflation or simple recession.
Tricky Combination
Traditional anti-inflation policies (like tight money) may worsen unemployment, and expansionary policies may worsen inflation.
4. Causes and Consequences of Stagflation
Causes (often):
- Supply shocks (e.g., sudden rise in oil prices).
- Structural rigidities in labour and product markets.
Consequences:
- High inflation reduces purchasing power.
- High unemployment and low growth hurt businesses and workers.
- Policymakers face trade-off between controlling inflation and boosting growth.
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5. Policy Responses (Conceptual)
- For deflation – expansionary monetary and fiscal policies to raise demand.
- For stagflation – mix of:
- Supply-side policies (improve productivity, remove bottlenecks).
- Careful demand management to avoid further inflation.
6. Quick Revision Points
- Deflation: falling general price level, often with low output and high unemployment.
- Stagflation: combination of stagnation + inflation.
- Both situations are harmful for business planning and employment.
7. Quiz Time 🎯
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