ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Deflation, Devaluation and Employment

Deflation, Devaluation and Employment

For the first time since the 1930s there is an apprehension that, following Japan, the United States and the euro-zone of Europe are likely to enter a state of deflation that entails a vicious circle of falling prices, lower income and fewer employment. To meet the challenge the US Federal Reserve Board has adopted a policy of reducing interest rate to almost zero. This note argues that the Fed policy of almost-zero interest rate tilts the factor-price ratio severely against labour vis-à-vis capital. In a regime of zero interest rate the economy would minimise the use of labour, replacing it by capital as far as possible. The professed goal of attaining the 'potential output' that means full employment, inter alia, will be defeated by the very policy that seeks to close the 'output gap'. This note constructs an alternative or additional policy to combat deflation. It also alerts third world countries that America and Europe may resort to competitive devaluation in order to export their deflation to third countries.

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