In Economics the debate usually starts with variables
not adjusted for inflation like nominal interest rate, nominal prices of
investment assets, nominal wages, nominal exchange rate including others not
mentioned here and as the argument deepens, a closer look at the situation
shows that the debate always comes to a point where the description cannot be
completed without real variables like real interest rate, real wages, real
prices of financial assets, real exchange rate i.e. inflation adjusted values
of the variables. Sometimes the economists also tend to focus majorly on
nominal or market variables rather than real variables because the trajectory
of growth of an economy is supported more by increasing prices or inflation
rather than deflation. We generally assume higher prices or inflation as result
of increase in income, demand and growth-rate; economists very occasionally
presume deflation as a consequence of growth unless the economy is going
through a down turn. Also, because more money supply always push inflation and
expected inflation, because the quantity theory of money says so. Therefore,
economists rarely try to increase real variables because they do not assume
deflation as an outcome of economic stimuli. One more reason is the downward
rigidity of commodity prices and services, as put by Keynes
Economist and layman never think that prices might
also go down as a result of expansion. However, a central-bank does not want to
favor and communicate deflation because that would stifle supply and employment
by increasing the value of money and thereby debt which is expected to
incentivize investment, but sometimes the economists forget that increase in
the value of money would also increase the real rate of return on investment
and may also decrease real cost of investment by lowering the prices of factors
of production. The real-investment would be cheap and real returns could also
increase. But, the policy makers never commit deflation because they do not
believe that prices may fall as a result of more money-supply.
Nonetheless, it is possible to have deflationary price
regime because more money-supply would lower interest rate and cost of
borrowing thereby increasing supply and lowering the prices.
This is evident is most of the developed countries stuck
in deflation and liquidity-trap even with so much of monetary and fiscal easing
Japan, Europe, US (still the interest rate is too low to qualify for the liquidity-trap).
These economies are showing a deflationary bias in their price-trajectory.
Although, productivity has increased with a lower rate but the population
growth-rate has also gone down which has made supply outstrip demand aggravated
by recessionary and slowdown outlook in many parts of the World.
Lower price and price expectations would make people
feel richer, increase real wages and demand, and growth. Lower prices may help
boost demand and clear the market. Once Ben Bernake, the former FED-Chief,
himself said that” little deflation is not bad”.
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