CDS (I) 2023 General Knowledge · Question 66 of 120

Correct — A, deflation. Deflation is a sustained fall in the general price level, which is inflation turned negative — not merely a slower rise. The distinction matters and is regularly tested: prices rising more slowly than before is disinflation, and the index is still going up. In deflation the index itself falls, so money buys more tomorrow than today. That sounds pleasant and is not, because households postpone purchases in the expectation of lower prices, firms see demand fall and cut output and wages, and the real burden of existing debt rises since the rupees owed are now harder to earn. Japan's long stretch of falling prices after the early 1990s is the standard case study.

• (b)stagflation — Stagflation is the opposite combination — output growing slowly or not at all while prices rise quickly. It pairs stagnation with inflation, which is what makes it hard to treat, since the cure for one worsens the other.
• (c)devaluation — Devaluation is about the external value of the currency, not the domestic price level. It is a deliberate government act under a fixed exchange rate regime, raising the exchange rate so that the domestic currency becomes cheaper for foreigners, and it tends to raise domestic prices by making imports dearer.
• (d)recession — A recession is a decline in output and employment, not in prices. The two often travel together, but they are different variables — an economy can contract while prices still rise, which is precisely what stagflation describes.

The general price level moves in four patterns worth naming. Inflation is a sustained rise. Disinflation is a fall in the rate of that rise, with prices still increasing. Deflation is a sustained fall in the level itself. Reflation is a deliberate policy of pushing prices back up after deflation. Only the third of these is what this question asks for, and it is measured the same way as inflation — by a price index such as the Consumer Price Index turning negative year on year.

This is a definitions item, and definitions items are lost by matching a mood rather than a meaning. All four options carry a sense of things going badly, so the way through is to ask what variable each one is about. Deflation and stagflation are about prices, devaluation is about the exchange rate, recession is about output. Two of the four therefore concern a different quantity altogether and can go. Between the remaining pair, stagflation is a compound — slow growth together with rapid inflation — so it cannot describe a fall in prices. The examiner's word 'sustained' is doing deliberate work as well: a one-month dip in the index is not deflation.

• Deflation is a sustained decrease in the general price level — inflation below zero.
• Disinflation is different: prices are still rising, only more slowly.
• Stagflation is slow growth combined with rapid inflation.
• Devaluation is a deliberate reduction in the external value of a currency under a fixed exchange rate regime, and it tends to raise domestic prices.
• Deflation raises the real burden of debt and encourages households to postpone spending, which deepens the downturn.

• Confusing deflation with disinflation. In disinflation the price level is still rising.
• Treating recession and deflation as the same event. One is about output, the other about prices.
• Assuming falling prices are good for the economy. Sustained deflation deepens a downturn.

As a straight definition, as a which-of-these-describes item, or as a pairing of an economic term with the situation it names.

• practice — not a real PYQ

  A fall in the rate of inflation, while prices are still rising, is called

  • (a)deflation
  • (b)disinflation
  • (c)reflation
  • (d)stagflation

  Answer(b) disinflation — the price level continues to rise, only more slowly; in deflation the level itself falls.

• practice — not a real PYQ

  An economy experiencing slow growth together with a rapidly rising price level is said to be in

  • (a)deflation
  • (b)recession
  • (c)stagflation
  • (d)reflation

  Answer(c) stagflation — stagnation and inflation at the same time, which is what makes it difficult to treat.