Deflation

Deflation is the opposite of inflation. In the words of Prof. Crowther,”deflation is the state of the economy where the value of money is rising or the prices are falling”. 

This definition is not free from defects. From this definition, it appears that every fall in the price-level is deflation but actually this may not be so. Sometimes the price-level starts falling down without any contraction in the supply of money. Now such a fall in the price-level cannot be called deflation. 

According to Prof. Pigou, “Deflation is that state of falling prices which occurs at that time when the output of goods and services increases more rapidly than the volume of money income in the economy”. 

Thus, according to Pigou every fall in the price-level is not deflation. Deflation occurs at that time when the output of goods and services increases at a faster rate than the money income. A fall in prices in the following situations may be termed deflationary according to Pigou.

1. If the money income diminishes but the output remains constant.
2. If the money income and the output both diminish but the money income diminishes much more rapidly than the output.
3. If the volume of output increases but the money income remains constant.
4. If the volume of output increases but the volume of money income diminishes. In each of the cases, the fall in prices will be deflationary. 

Effects of Deflation

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)