Deflation, is it good?

Inflation is a term widely used to describe rise in prices of a specific set of goods and services. It is measured using CPI (Consumer Price Index) which estimates the price of a basket of items on a specific date. A fall in CPI over a given period is called "Deflation" and an unchanged CPI is called Stagflation. Fast growing developing economies like India, China and others experience high inflation continuously for decades. Hence one of the major parameters which is monitored religiously by their Central banks is Inflation which is meticulously monitored and kept under control. This is specifically true in democracies where a price rise can create popular pressure on government to intervene immediately. During the present economic slow-down when consumers are rapidly loosing their purchasing power, it seems quite logical to have deflation (negative inflation), because producers would invariably try to lower the prices in order to maintain the revenue coming at the expense of lower margin. So is this good for the economy? More importantly will it help to reverse the downward shift we are experiencing right now?

Certainly not! Even though at a micro level such price reduction can help both the buyer and seller, at a macro level it is extremely harmful for the overall economy. A deflation creates an expectation of fall in price in the future and encourages consumers to push their buying decision. For example, suppose I am planning to buy a car. I came to know that the prices of car is going to fall and read an article in WSJ in support of that. I will obviously postpone my procurement decision expecting to get a better deal in future. Most other consumers in my circumstance would also follow the suite and this will impact the car manufacturer's present sales. In general if prices of goods and services are predicted to move southwards than most consumers would postpone their buying and this can slow down the economy rapidly. This is exactly what happened to Japanese economy in early 90's and it took several years for them to get out of it. Economists generally prefer a moderate inflation and accordingly tweak the money supply to the economy.

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