Deflation affects all aspects (i.e., economic, social and political) of the life of the country. Various effects of deflation are discussed below:
(A) Effects on Different Sections of Society
Deflation influences different sections of the society in the following manner:
Deflation adversely affects the producers:
(a) During deflation, production costs do not fall as rapidly as the prices of finished goods,
(b) When the producer buys raw material and other inputs, he pays a higher price, but by the time he reached the market to sell his finished products, the prices of raw materials will fall because of deflation. Thus the producer will be forced to sell his products at a lower price;
(c) The demand for commodities goes on falling: due deflation. As a result of this the profits of the producer will fall and there will be overproduction of the commodities. Similarly, deflation also adversely affects the farmers, particularly the small farmers.
The traders are also adversely, affected during deflation. When they make purchases, they have to pay higher prices, but when they sell the products prices fall due to deflationary trend. As a result, the traders are likely to lose.
Different types of investors are affected differently due to deflation:
(a) The fixed-income investors (like debenture and bond holders) gain by deflation because incomes remain constant while the prices fall.
(b) The variable income investors (like equity holders) will lose during depression, because their incomes fall with the falling prices.
4. Salaried and Labour Classes:
Wage earners and salaried persons gain during deflation. The reason is that with the fall in prices, the wages and salaries cannot be reduced; such attempts will be strongly opposed by the trade unions.
The consumers generally gain due to falling prices because the purchasing power of their money rises. Consumers are of two types: (a) The consumers whose income remains fixed (i.e, salaried persons) will be benefited by deflation. (b) The consumers whose income falls during deflation (e.g., profit earners) may lose during deflation.
6. Creditors and Debtors:
During deflation, the prices fall and the value of money rises. As a result, the creditors tend to gain and the debtors tend to lose.
(B) Other Effects on the Economy
Deflation also affects the general life of the economy in the following way:
(i) Tax-payers are adversely affected in the deflationary period because due to falling prices, the value of money rises and the real burden of taxation increases.
(ii) The government faces an increase in the rea 1 burden of public debt.
(iii) Due to falling prices and profits, the entrepreneurs reduce output. Some small businesses may close down. This results in the unemployment of workers and employees.
(iv) Banking business also suffers during deflation because the number of borrowers falls sharply due to general recession in the economy.
(v) Like the private sector units, the public sector enterprises also suffer losses during deflation when the prices fall.
(vi) Deflationary conditions lead to greater number of industrial disputes and thus create industrial unrest in the economy.
(vii) During deflation, the pace of economic growth slows down or even suffers a setback and the economic, social and political life of the country get disturbed.
In short, deflation is even worse than inflation. Middle class people gain at the expense of the richer classes. Reduction in output and wide-spread unemployment adversely affect the economic life of the country and lead to social unrest.