Deflation: Meaning and Effects

Deflation is a sustained, persistent fall in the general price level — the exact opposite of inflation. When prices fall, each rupee buys more than before, so the purchasing power of money rises.

Deflation should not be confused with disinflation, a related but different idea: disinflation is merely a slowdown in the rate at which prices are rising (inflation is still positive, just smaller than before — e.g. the inflation rate falling from 8% to 5%), whereas deflation means prices are actually falling (a negative inflation rate). This distinction is a common source of confusion and worth stating precisely in an exam answer.

Effects of deflation are broadly the mirror image of inflation's effects:

• Fixed-income earners and creditors gain — their fixed money income or the fixed sum owed to them now buys more (or is worth more in real terms) than before.
• Producers, businessmen and debtors lose — falling prices squeeze profit margins (selling prices fall while some costs, especially wages and old debts, are slow to fall), and a debtor now has to repay a debt whose real burden has increased. …