Deflation refers to that situation where there is general decline in prices of goods and services, it happens when inflation rate fall below zero percent. In order to understand this concept better let’s look at advantages and disadvantages of deflation –
Advantages of Deflation
- Due to deflation prices of many goods and services fall which in turn leads to lower expenditure bill for all class of people and due to this middle and poor class people tend to be happy as their monthly budget gets reduced drastically.
- Another advantage of deflation is for those people who are looking to take fresh loan because in times of deflation rate of interest is very low as central bank try to control deflation by reducing rate of interest so that people invest less in fixed deposits and spend more which in turn will increase the money supply leading to control in deflation and hence people who are looking for taking loan or debt for housing or business are benefited due to lower interest rates during deflation.
- Deflation hits hard rich people as compared to poor people because in case of deflation value of majority of assets falls and rich people hold more assets as compared to poor people and hence they are at more loss as compared to poor people. In a way one can say that deflation helps in narrowing the gap between the rich and poor.
Disadvantages of Deflation
- The biggest disadvantage of deflation is that it creates problem of unemployment because due to deflation prices of goods falls which results in lower profits for companies which in turn force the companies to reduce the production of goods by cutting down production in factories or even closing some factories which in turn results in mass scale layoff of workers and since economy is facing deflationary pressure there is no scope for new employment opportunities and hence percentage of unemployed people rise significantly in deflation
- Deflation initially looks good due to declining price of everything but as time passes by the deflation shows its true devastation in the form of lower wages or salaries to employees as companies don’t have profits to pay its employees, lower production and lower growth which ultimately affect everyone and it leads to vicious circle where no company or individual wants to invest and everyone wants to keep cash with them.
- Individuals or companies who have already taken loan are worst hit because these people would be paying higher rate of interest as time of value of money work in reverse direction in case of deflation. In simple words cash is the king in deflationary times as holders of cash are benefited and holders of assets are at disadvantageous because the value of assets keeps declining in case of deflation.
As one can see from the above that deflation has both advantages and disadvantages, however its disadvantageous are more severe and have long lasting impact and that is the reason why governments across the world prefer inflation rather than facing deflation.