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Why Deflation Is Bad For Economy: Case of Zero Inflation

India's WPI inflation is in negative territory since last 1.5 years. While it looks comforting to general masses as decrease in prices increases there real economy and thus purchasing power but many economist are concerned that sustained negative inflation could have harmful consequences on Indian economy as sustained negative inflation could be termed as deflation instead of disinflation.

What is Deflation

Deflation is a decrease in general price levels of throughout an economy. If there is a higher supply of goods and services but there is not enough money supply to combat this, deflation can occur. Deflation is mainly caused by shifts in supply and demand.

Disinflation, on the other hand, shows the rate of change of inflation over time. The inflation rate is declining over time, but it remains positive. For example, if the inflation rate in the India was 5% in January but decreases to 4% in March, it is said to be experiencing disinflation in the first quarter of the year.

Reasons behind Negative WPI Inflation in India

While prices of pulses and onion have increased greatly in last few years, However WPI is negative from more than 1 year. There are various reasons behind this phenomenon.

• In WPI primary articles which include food articles is given very less weightage.77% weightage is given to Fuel, Power, Light & Lubricants and Manufactured Products. Both Fuel prices and manufactured prices have been at all time low due to number of global and domestic reasons, which has put WPI into negative territory

• While global factors include slump in the price of oil and commodities. The domestic factor include lack of demand which has pushed the prices down

• The food inflation has also decreased significantly in last 2 years due to number of reasons.

(1) Firstly MSP had been one of the major reasons for inflation however since the NDA government came to power it has increased only by 6% which has a moderating effect on on inflation.

(2) Secondly Over production in certain crops like sugercane, rubber has slumped there prices.

(3) Thirdly during drought period The timely release of Buffer stock, Strict action against hoarders and Timely imports have overcome shortage of supply.

Problems of deflation

Economist believes that inflation should be 2-3% as deflation creates number of problems for the economy.

• Discourages consumer spending-When there are falling prices, this often encourages people to delay purchases because they will be cheaper in the future.

• Increase real value of debt- Deflation increases the real value of money and the real value of debt. Deflation makes it more difficult for debtors to pay off their debts. Therefore, consumers and firms have to spend a bigger percentage of disposable income on meeting debt repayments. (in a period of deflation, firms will also be getting lower revenue, and consumers will likely to get lower wages). Indian corporates are already over leveraged, negative inflation would make it difficult for them to repay debts as their debt burden would increase.

• Real wage unemployment- Labour markets often exhibit 'sticky wages'. In particular, workers resist nominal wage cuts (no one likes to see their wages actually cut, especially when you are used to annual pay increases. Therefore, in periods of deflation, real wages rise. This could cause real-wage unemployment. 

• No incentive to produce-Producers whether manufacturing or Farmers need some inflation so that their profits can increase. If prices would be falling they would reduce their production which could create supply side shortage in long run.

Is India Facing Deflation Or Disinflation

India is nowhere near deflationary situation. Although inflation rates have fallen sharply, inflationary expectations remain high and positive, indicating that India is witnessing dis-inflation, rather than deflation, which is a welcome development after years of high inflation. More importantly, we would argue that India is witnessing a period of 'good' dis-inflation.

Recent decline in price levels in India is mainly on account of fall in fuel and commodity prices, both external factors. As far as common man is concerned, food prices still remain high and as vulnerable to monsoons as they have been in the past. Basically, the reason for price fall is not a lack of demand. CPI (Commodity Prise Index) which is a more reliable indicator of inflation is close to 6% hence, we do not believe that India will witness a real deflation in the future.

Lower inflation has raised households' real disposable incomes, which has contributed to increase in consumer durables like automobiles and other household goods.

 

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