Too low inflation is not only a disincentive for production decision but it can also delay consumer spending in anticipation of further fall in inflation and dampen demand at a time when its revival is critical for triggering the upturn.
Low inflation also imparts inflexibility to nominal wages and labour markets, causing higher unemployment and deepening the recession. In a period of falling inflation the ability of firms to make adjustment in real wages is severely constrained and this leads to inefficiency in the allocation of resources and a rise in unemployment.
In the Indian context, the average inflation rate (on the basis of movements in the wholesale price index), has been around 8 per cent per annum over the last three decades.
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A decade-wise comparison reveals that the inflation rate has been quite stable: it averaged 9.0 per cent per annum during the 1970s, 8.0 per cent during the 1980s and was 8.1 per cent during the 1990s (Chart 1). From the last half of the 1990s, there is a perceptible lowering of the inflation trend.
The current low inflation reflects both demand and supply factors. Accordingly, periods of low inflation for a year or so may not break public