22 December 2014

Yuva Anandan

Yuvaraj Anandan - Leading European Investment Bank

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Low inflation vs. No inflation vs. Deflation

13 January 2009  |  10014 views  |  0

With Inflation in India rapidly going down(now at 6-7% from 14% 6months back) and potentially heading into deflation. what & why that would be any good for indian economy in long-run? I think, answer would be very subjective based on who you ask and for India's scenario it would very difference due to high % of unorganized workforces/SMEs.

Inflation has reached 6.61% for the week ended 6-Dec. It is likely to go lower, from reduced petrol prices, interest rate cuts and drop in global crude prices ($36 and not quite counting). Source & for more detail(chart): India Investor's Blog 

Inflation is defined as increase in the price level of general goods & services. And Its most due to: demand increase, supply decrease, which cause increase in general pricing. Increase in production cost (& material cost) will decrease supply. If this remains the same, and assuming that economic growth is another of macroeconomic objectives, then an increase in demand is necessary to stimulate economic growth within an economy, causing demand-pull inflation. That's one of many reason why inflation is considered as necessary for a growing economy.

Low inflation is better because:

• No increase inflation (or zero inflation) economy might slipping into deflation. Decrease in pricing means less production & wages will fall, which in turn causes prices to fall further causing further decreases in wages, and so on. so a low rate of inflation will provide safety barrier against this. Also its very hard for monetary bodies to correct deflation. Offering negative Interest rates wouldn't be any effective.

• Low inflations will keep interest rate positive also provides incentives for investement instead of having decreasing-value-money. Particularly good for higher return, since higher risk projects that are still beneficial to the economy would otherwise may have been ignored if firms/investors were not looking for inflation exceeding returns.

• People and trade unions are naturally very reluctant to accept any nominal cuts in wages. so salaries are very hard to negotiate downwards. And if downward adjustments were not possible then it would cause instability & lack of growth due to disequilibrium in the economy. Instead of nominal cuts but by having wage increase lesser than inflation could mean real wage decreases. so in some sense inflation is grease for economy wheels.

I remember reading- Technically, Growth with no inflation is feasible by having supply-side policies. Policies which helps to increase in supply that inturn allows the economy to grow through its increased demand and therefore greater consumption, due to many factors. An increase in supply equivalent to that of the increased demand would theoretically result in inflation of zero. Also the increased supply would help stimulate economic activity and economic growth in the long-run, serving the economy better for future generations.

On one hand, Low inflation rate is better than no inflation rate because there is a negative relation between inflation and unemployment. If we reduce the inflation rate to zero, it might increase unemployment rate which ofcourse is not good. Loss due to increase in unemployment rate is multitude- not only skill loss but tax revenue, social order, and etc. Thus by increase the inflation rate, consequently, unemployment rate will decrease and economic growth will increase.

And on the other hand, low rate of inflation in not good as compare to zero inflation rate. since as per definition- inflation rate is an increase in general price level. I.e. poor people with fixed (/low) income will suffer from inflation.

Surely one of many good things about inflation is- it does help in preventing people hoarding money, since money looses value a small percent every year. Thus, triggering people to use money in some kind of investment products, which encourages a bit more investment or a bit more spending than would otherwise occur.

Related: How is inflation rate calculated in India?

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job title Business Analysis & Change Mananger
location Singapore
member since 2008
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Business Solution Analysis & Change Manangement with Leading European Investment Bank to re-align front/middle/backoffice business processes & re-platforming private wealth management business

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