Why deflation is dangerous than inflation?
Both inflation and deflation are bad for the economy. But of the two, deflation is more dangerous. If prices of goods are coming down, business people will stop investment as there is the risk of loss. In this way, deflation discourages many desirable factors in the economy - production, investment, employment and thus economic growth.
The major side effect is that it is a disincentive for the producers. Gradually, deflation can worsen into a recession and depression. It is often said that among the two undesirables- inflation and deflation; deflation is more dangerous. Deflation discourages the business psychologically. It adversely affects business momentum. Massive deflation may develop into depression as happened during 1920s. Hence, Central banks always try to avoid deflation.
On the other hand, in the case of inflation, mild level of inflation incentivizes production and investment activities. This in turn increases level of employment and economic growth. From the angle of business momentum low inflation is a desirable factor.
The definition of price stability also tells us that low level of inflation is preferable to deflation. Price stability is the most important objective of central bank’s monetary policy. Price stability is defined as low and stable inflation. There is no meaning that price stability is absence of inflation. Rather, low level of inflation is a welcome factor that may stimulate the economy.
In India, the RBI considers that 4% inflation is good for the economy. In the US, the central bank has a 2% inflation target.
