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For the last five decades, there is hardly any country which has passed through a period of persistent fall in the general level of prices. Thus, analysis of deflation has been relegated to a minor position. Even then, it is possible to understand the causes of deflation. As deflation occurs, when production of goods and services rises at a faster rate than the money income, the two causes of deflation are deficient demand and excess supply.

On the demand side, money shortage, fall in disposable income and fall in business outlays may lead to contraction of credit, consumption expenditure and investment expenditure on account of tight money policy, higher rate of taxes and falling profit margins respectively. This will have an adverse effect on the level of income and employment in the country, resulting in deflationary situation in the economy. Deflation may also be caused by factors acting on the supply side. Over investment may cause a rapid increase in production surpassing the demand. Such situation may breed deflationary forces in the economy.

Deflation can also arise from the anti-inflationary measures, when their overuse may contract the money supply. Thus, deflation arises due to deficiency of demand to lift what is supplied. In other words, there are too many goods chasing too little income.

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