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Deflation In China UPSC NOTE


What is deflation?

  • Deflation is a term used to refer to a general fall in the prices of goods and services in an economy. 

  • The nominal costs of capital, labour, goods, and services fall as a result of deflation, even if their relative prices remain unchanged.

  • Consumers benefit from deflation on the surface because they can buy more goods and services over time with the same nominal income.

  • Deflationary Gap: It is the difference between the general level of prices and the fall in the level of prices due to deflation.

  • Deflation can be particularly harmful to borrowers, who may be forced to repay their debts in money that is worth more than the money they borrowed, as well as financial market participants who invest or speculate on the prospect of rising prices.

Why is it a worry?

  • Many economists believe that deflation is a sign of falling demand for goods and services which could lead to a slowdown in economic growth.

  • According to them, the demand for goods and services is the driver of economic growth. 

  • Falling prices, can also push buyers to postpone their purchases expecting lower prices in the future; this in turn can further dampen demand in the economy, they argue. 

  • A certain degree of inflation is believed to be necessary for the full utilisation of the resources in an economy. 

  • Further, it is said that deflation can lead to business losses and lower growth as costs remain sticky. 

  • It can also mess up credit contracts as borrowers will have to pay back lenders more in real terms.

  • Other economists point out that deflation per se may not be a problem. 

  • Many economies including the U.S. and China in the past, they note, have experienced deflation during times of rapid economic growth. 

  • Even a country like Japan, which has been plagued by persistent deflation for years, actually witnessed a rise in per capita real income levels during the era of deflation. 

  • Deflation in such cases is the result of a rise in the supply of goods and services that outpaces the rate of money supply growth. 

  • It should also be noted that it is not quite uncommon for countries experiencing high price inflation to suffer from low or even negative economic growth at the same time. 

  • However, deflation can also be a sign of economic turmoil. 

  • During times of economic crises, spending by individuals can drop temporarily as they become more cautious. 

  • Sometimes deflation in the official price indicators can also be a sign of a process of reallocation of resources. 

  • Spending on goods whose prices are captured by official indicators may drop while spending on other goods may even rise.

  • These economists also argue that deflation need not cause consumers to postpone purchases as widely believed. 

  • It is not the prices that determine consumer demand for goods and services, but it is rather consumer demand that determines prices. 

  • The direction of causation runs from consumer demand to prices rather than the reverse.

  • Moreover, deflation need not cause sustained business losses since businesses can adjust what they pay for their inputs according to what their customers are willing to pay for their goods and services.

Why is China experiencing deflation?

  • China is experiencing deflation at a time when the People’s Bank of China, or the Chinese central bank, continues to keep interest rates low to boost demand in the economy. 

  • This is in contrast to other central banks which have been tightening policy to fight high inflation after the Covid-19 pandemic. 

  • The likely reason behind Chinese deflation may not be the lack of liquidity but rather something more fundamental.

  • A proper study of the Chinese money supply and monetary transmission can help us come to a definite conclusion on the reason behind the current bout of deflation. 

  • It should be noted that the Chinese economy has been experiencing turmoil even before the pandemic, in the property sector which contributes to a share of Chinese GDP. 

  • The Chinese policymakers have been trying to bring about a soft landing of their economy.

  • Credit booms like the one witnessed in China can cause the misallocation of resources and the bust can involve a fall in broader prices.



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Learnerz IAS | Concept oriented UPSC Classes in Malayalam: Deflation In China UPSC NOTE
Deflation In China UPSC NOTE
Learnerz IAS | Concept oriented UPSC Classes in Malayalam
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