Thursday 17 March 2016

Low inflation rate could happen "naturally"


My opinion is that the cost of production is always diminishing due to improvement in technology and productivity. As the cost of production decreases, if the market is competitive, the price will decrease as well. From this aspect, it is reasonable to see a deflation in long run. However, from our recent experience, this is not the case. When our economy grows rapidly, we usually see a very high inflation. One of the reasons that why high inflation happens is that our population grows at a faster rate compared with the improvement of technology and productivity. Another reason is that what we consume has changed when we receive higher incomes. When economic growth is fast, our incomes increase as well. When we have higher incomes, we tend to consume better quality goods and services which have higher prices. The previous cheap and poor quality goods and services are forced out of the market and excluded from the equation calculating the CPI. Based on these two reasons, we can have ideas what causes the current low inflation rate. Firstly, if we have a real GDP growth rate which is higher than the country's population growth rate. This adds deflationary pressure on the economy. Moreover, when we can hardly improve the qualities of our goods and services, we will continue our previous consumption. When the cost of production as well as the prices are diminishing, we will have a deflation in the economy. To conclude, the problem of deflation is not necessarily caused by the lack of the market confidence or economic downturn.

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