We are worried either way

WPI-based inflation peaked last August at 12.5 per cent, before falling to minus 1.61per cent for the week ended June 6.

This results in an increase in the real value of money — a negative inflation rate.
conversely,inflation reduces the real value of money over time.To eliminate this, RBI engineers try to reduce the lending rate, definetly Bank will not lend at negative interest rate.

In Japan,Deflation started in the early 1990s. The Bank of Japan and the government have tried to eliminate it by reducing interest rates (part of their 'quantitative easing' policy), but this was unsuccessful for over a decade. In July 2006, the zero-rate policy was ended.

Systemic reasons for deflation in Japan can be said to include:

1.Fallen asset prices. There was a rather large price bubble in both equities and real estate in Japan in the 1980s (peaking in late 1989). When assets decrease in value, the money supply shrinks, which is deflationary.

2.Insolvent companies: Banks lent to companies and individuals that invested in real estate. When real estate values dropped, these loans could not be paid. The banks could try to collect on the collateral (land), but this wouldn't pay off the loan. Banks have delayed that decision, hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks make even more loans to these companies that are used to service the debt they already have. This continuing process is known as maintaining an "unrealized loss", and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy. Improving bankruptcy law, land transfer law, and tax law have been suggested (by The Economist) as methods to speed this process and thus end the deflation.

3.Insolvent banks: Banks with a larger percentage of their loans which are "non-performing", that is to say, they are not receiving payments on them, but have not yet written them off, cannot lend more money; they must increase their cash reserves to cover the bad loans.

4.Fear of insolvent banks: Japanese people are afraid that banks will collapse so they prefer to buy gold or (United States or Japanese) Treasury bonds instead of saving their money in a bank account. This likewise means the money is not available for lending and therefore economic growth. This means that the savings rate depresses consumption, but does not appear in the economy in an efficient form to spur new investment. People also save by owning real estate, further slowing growth, since it inflates land prices.

5.Imported deflation: Japan imports Chinese and other countries' inexpensive consumable goods, raw materials (due to lower wages and fast growth in those countries). Thus, prices of imported products are decreasing. Domestic producers must match these prices in order to remain competitive. This decreases prices for many things in the economy, and thus is deflationary.

In India too we faced negative inflation some 32 years back.

When spiraling inflation happens we are worried because the purchasing power of money comes down. When there is deflation the purchasing power of money actually goes up! Yet zero inflation or negative inflation (that is, deflation) is not necessarily good. we are worried either way.

Naras