What are the Root Causes of Deflation

There are a number of causes of deflation, but before talking about all these causes of deflation, it is also important to talk about deflation that what is deflation? How different authors define deflation: – Deflation is gradually decreased in the prices of general products and services and known as deflation. Different authors define the deflation in different words.

1. According to G. Thomas “It is a reduction in the general price level due to a decrease in the economic activity of a nation”.
2. According to James Phillips “It is a period during which level of prices declines and the value of money rises”.
3. According to William J. Baumol “It refers to a sustained decrease in the general price level”.

Root Causes of Deflation

Below are the list 12 different causes of deflation, which can be seen everywhere and in every country of the world, where we noticed the deflation.

1. Excess Production

The production of goods and services in excess of its demand is also from one of the root causes of deflation. The price level comes down. The producers may not be able to continue their output at present level. The producers may make wrong calculations about future demand. The optimistic attitude is adopted due to high profits at present time. The unbalance demand and supply of goods and services create trouble for the people through deflation.

2. High Taxes

A high rate of income taxes means the low purchasing power of general public. The decrease in income due to taxes force the people to buy less than before. The demand for goods is curtailed. The current ratio of production takes time to adjust supply of goods. High tax forces the people to lower their demand rate. The excess supply is the result of lower demand. The deflation is invited due to decrease in purchasing power. So this is also from one of the root causes of deflation.

3. Securities Sale

The sale of securities is a cause of deflation. The shares and debentures are sold in the market. The people like to invest their idle money in shares. The purchasing power checked to the extent of investment in shares and debentures. They can buy less good due to low spending capacity. The demand for goods is lowered. The supply increase the demand limits. The excess supply brings deflation in the country.

4. Less Demand

The decrease in demand is also from one of the root causes of deflation. The demand may decrease due to decrease in income, wages and population. The excess supply and less demand is a set back to the economic activities. Thus decreasing the rate of demand brings deflation in the free economic system.

5. No Storage

The business may not have storage facilities. It is bound to supply the whole products in the market. The lack of storage means failure to adjust supply according to demand for goods. The perishable goods cannot be kept for long period of time. In the absence of proper storage space the supply becomes a problem. The sellers have no choice but to sell the goods at any rate. The result is that the price level comes down.

6. Surplus Budget

The surplus budget is a cause of deflation. The state revenue is excess as compared to expenditure. The supply of money is reduced in the market. The income of people comes down. The demand for goods is lowered, the activities lead towards deflation. The surplus budget is suitable during good trade period. Every year surplus budget is not a healthy sign for economic progress. Thus deflation is invited through low spending.

7. Excess Saving

Excess saving is a cause of deflation. The banks can start saving scheme to collect deposits from general public. When saving exceeds the decreasing in spending. The demand for goods and services comes down. The investment facilities can attract the people to save more than usual. The purchasing power comes down which lowers the rate of demand so there is deflation.

8. Lower Profits

The low rate of profits is a cause of deflation. There may be competitions in the economy. The investment in any sector may be more than demand. The excess investment or tight competition lowers the rate of profit. The sellers try to clear their stock of goods. But excess supply becomes a problem. The business parsons cut their profits to retain in the market. A stage comes when profits becomes zero. The lower profits induce the people to cut the activities so there is deflation.

9. Reserve Ratio

An increase in reserve ratio is a cause of deflation. The commercial banks maintain reserve ratio under the law. The central bank has powers to regulate the reserve ration. When reserves ratio is raises the banks are bound to keep cash with them. The lending capacity is lowered in order to lower the money supply in the market. The business activities come down. The reserve ratio brings deflation in the economy.

10. High Bank Ratio

The high bank ratio is also a cause of deflation. The bank is an official rate of central bank for discounting bills of commercial banks. When bank rate is raised the banks cannot issue more loans. The recovery of loans may be accelerated. The money supply decreases. The business working is affected due to less loan-able funds. Thus high bank rate can work for deflation.

11. Population Decrease

Population is also from one of the root causes of deflation. The movement of population may be due to any reason. The result is that demand for goods and services comes down. The goods and services are produced for sale in the market. All marketing activities are useless when there is no demand. The population is a source of demand for purchase of goods. The decreasing rate is an alarm to people and government about deflation.

12. Currency Contraction

Currency contraction is also a cause of deflation. The monetary authorities may decide to cancel the old ones. Also there are many ways to block the currency in circulation. The purpose is to reduce the money supply. The result is that there is deflation even though contraction of money is for a temporary period of time.