Inflation versus Deflation: Which of the Two is Better? | Economics

Which of the two is better- inflation or deflation? Inflation is a phenomenon of rising prices without causing change in the levels of employment and output. Deflation, on the other hand, is a phenomenon of falling prices accompanied by a fall in the levels of employment and output. Both inflation and deflation are harmful for society and have undesirable economic consequences.

But when the question of a choice between the two evils of inflation and deflation arises, the lesser evil is to be selected. An inflation is the lesser evil. Thus, inflation is preferred to deflation because the former is lesser of the two evils. In the words of Keynes, “Inflation is unjust and deflation in inexpedient. Of the two deflations is worse.”

Inflation in Unjust:

Inflation is considered unjust in the following grounds:

(i) Inflation redistributes income in favour of the rich (profit earners) at the cost of the poor (wage earners and consumers).

(ii) Inflation increases economic inequalities through its redistributive effect. It transfers purchasing power from poorer to the richer sections of the society and thus widens the gap between the rich and the poor.

(iii) Inflation is regressive in its effect. It adversely affects those who are already weak and cannot protect themselves. It specially hits the middle classes who suffer most during inflation.

(iv) Inflation affects different people differently and in different degrees and thus alters the economic and social relationships in the country. It takes away wealth from some groups of the society and transfers it to others arbitrarily, ignoring the maxim of equity.

(v) It is socially demoralising. It encourages the spirit of gambling. It promotes speculative activities and diverts business skill and efficiency from productive to speculative activities.

(vi) It creates money illusion and results in artificial prosperity which is short-lived.

(vii) It reduces the value of money and thus erodes real saving of the people.

(viii) When the government adopts the inflationary method of deficit financing to cover up the deficit in its budget, the prices go up and this inflationary rise in prices diverts the goods and services meant for public consumption to the government which is totally unjust and unequitable.

Deflation is Inexpedient:

Deflation is considered inexpedient because of the following reasons:

(i) Deflation, by reducing prices and output, leads to a sharp decline in the national income and thus reverses the process of economic growth.

(ii) Deflation results in mass unemployment. Reduction in prices and profits forces the businessmen to close down their establishments or reduce their production, thus giving rise to large-scale unemployment.

(iii) Deflation leads to depression in the economy. Downward trend of prices and production gives rise to pessimistic conditions in the economy; economic activity contracts; scale of production is reduced, volume of investment falls; and no new investment is forthcoming due to depressed profit expectations.

(iv) Deflation, once starts, becomes cumulative. It goes on gathering momentum and the economic crisis becomes deeper and deeper with the passage of time.

(v) Deflation is undesirable from all sides. It adversely affects the social, economic, political and moral life of the economy. It curtails economic activity, causes mass unemployment, generates poverty and ultimately results in the complete ruin of the economy.

Inflation is better than Deflation:

Though both inflation and deflation have undesirable effects, but inflation is considered better than deflation.

The following arguments justify the preference for inflation:

(i) Inflation, though it redistributes income and wealth in favour of the rich and causes economic inequalities, does not reduce national income. Deflation, on the other hand, has the undesirable effect of reducing national income.

(ii) Inflation is a post-full employment phenomenon, while deflation is an under-employment phenomenon. In other words, during inflationary phase all factors of production are employed in some way or the other, whereas, during deflation, the problem of unemployment becomes more and more acute.

(iii) It is easy to control inflation by adopting various monetary and fiscal measures, but it is very difficult to recover the economy from deflation. Once deflation starts, it gathers momentum and the cumulative downward process ultimately takes the economy into severs depression.

During depression, the marginal efficiency of capital declines and the businessmen become pessimistic about the future of their investments. Under such conditions, monetary and fiscal policies become ineffective; they cannot restore the confidence of the entrepreneurs and compel them to increase investment.

(iv) Mild inflation is better than deflation from the point of view of economic development. Moderate monetary expansion by raising the price level and increasing the expenditures, can stimulate economic development in a depressed economy.

(v) Inflation is lesser evil- (a) Inflation is a single evil because it redistributes wealth in favour of the rich people arbitrarily. Deflation is a double evil because it not only redistributes wealth in the same arbitrary manner, though in favour of the poor people, but also, reduces output and causes unemployment (b) Inflation makes it increasingly difficult for the people to earn a good livelihood, while deflation deprives the people of their livelihood by rendering them unemployed; in other words, in inflation, people do not get enough, in deflation, they do not get anything at all.

In the end, it is true that Keynes prefers inflation to deflation. But, this does not mean that he is an inflationist. His preference for inflation over deflation is only a matter of choosing the lesser evil.

In fact, nowhere has he preferred inflation over the objective of full employment. He fully realises the dangers of inflation, particularly when it gets out of control and turns into hyper-inflation.