Evaluate a Government Policy of Inflation

Inflation is defined as a sustained increase in price levels. Deflation is defined as a sustainedfall in price levels. There are a handful of concerns as to why the MPC should be concerned,but also a few key reasons as to why price fall may not be so devastating.The first real concern would be the idea of speculative demand, where consumers anticipatefurther price falls in the long term, and so choose to temporarily save and spend at a laterpoint. As a result of lower demand, there will be further deflation, and firms will lose out onprofits and begin to see losses. Firms may be forced to lay off workers in order to maintain aprofits margin, and a fall in demand for goods and services may lead to AD falling overall,causing a slowing down of economic growth.A second concern would be the rise in value of debt. A fall in price levels increase the valueof money, and consumers with mortgages in particular may find that repayments take up alarger chunk of their disposable income. Similar effects can take place within firms and alsoa large scale government, who may encounter a worsening budget deficit. Increases in thevalue of repayments may lead to a reduced consumption, consequently leading to a furtherfall in AD and price level.Conversely, deflation may be caused by an increase in productivity of firms via a lowering ofcosts of production. As a result, price levels will reduce due to a rightward shift of the AScurve, benefitting economic growth in the process.Secondly, if there is a positive output gap with the economy currently ‘overheating’, a fall inprice level may have no or very little effect on a country and its output. Consequently thereis more benefit to the country as oppose to a concern for the MPC.In conclusion, the debate over whetherdeflation is a cause for concern depends onvarious factors including current economicsituations and productivity, the reason for theprice fall, and the impact for and response ofconsumers. A price fall can have the capacityto largely stunt and decrease economicgrowth, but the reason behind the price fall ispivotal, with an increase in supply andproductivity of firms in particular having apositive impact on the economy.