Deflation is the opposite of inflation which means a decline in the money supply or credit. Deflation may also be caused by decrease in spending which includes government or private sector spending. Central banks tend to decrease severe deflation in order to keep the price fluctuation to minimum level because deflation creates uncertainty in the country with decreased demand.
Deflation causes unemployment, uncertainty, closed factories and companies, bankruptcy, non repayment of loans etc. One way of controlling it is through the monetary policy by increasing the money supply so that it can be controlled. Deflation periods can be either short or long depending on the intensity but effective measures by the government can control it in time.
Deflation occurs when the inflation rate fall below 0 percent increasing the real value of money. This means that the person can but more goods with the same amount of money than before. Also deflation must not be confused with de inflation which means slow down in the rate of inflation. Inflation decreases the real value of money.
Let us assume that we have $10 and only ten items which cost $1 each. If the money is increased to $20 but the items remain the same the price will increase to 2$ each which is known as inflation. If the money is decreased to $5 and the items remain the same then the demand will decrease causing deflation. In addition deflation will also be caused if half of the money is hoarded thus, reducing the money supply.Deflation can be bad or good, and it all depends on the causes. It generally reduces the money supply in the market which can create a depression that can be temporary or permanent. It creates a spiral which results in stock market crashed, sucking all the money out of the market. Banks stop lending money thinking that people are defaulting, companies start firing employees with less profit to pay. These are the factors that create a negative image of the economy among the people abroad taking a negative impression. Lastly investment coming to the parent country decreases in deflation, and the gap further increases and chances of economy collapsing.
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