After more than five decades of relentless fight against inflation, central bankers world over face a new enemy, deflation. The prospects of a fall in price levels threatens to push the already weak economies further down and make the likelihood of a recovery bleak. The bitter experience of Japan, only adds to the ever-increasing anxiety. The Fed and ECB have taken a public stance to use every weapon in their arsenal to avoid deflation. For many economies across the world, deflation is the new Damocles' Sword.

The talk of deflation is just about everywhere. The IMF, the Federal Reserve, the European Central Bank, all of them either explicitly or in subtler terms have indicated that their one big worry today is the threat of deflation. The IMF has published a detailed report assessing the 38 largest developed and emerging economies on various parameters. Based on its studies and research the report categorically divided countries into those that face high, moderate or low risk of deflation. For its part the Federal Reserve (Fed), decided to sit tight on the federal funds rate of 1.25% in its recent Open Market Committee meeting. Its assessment said, "The probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pick-up in inflation from its already low level." But the most telling reaction came from the European Central Bank (ECB). It did two thingschanged its inflation target from `less than 2%' to `less than but close to 2%'; and cut down interest rates from 2.5 to 2%.

Deflation, defined as the fall in the general price level, could be a boon or a bane depending on why it occurs. A fall in price level could occur for two fundamental reasons, an increase in supply or a fall in demand. An increase in supply creates a supply side deflation, which is also called as benign deflation or good deflation. This kind of a fall in prices is essentially caused by technology improvements, efficiency gains, cost-cutting measures etc., that enhance the supply of goods while keeping costs down. This reducing cost of manufacturing gives the producer a chance to supply goods at lower prices. If a producer so chooses, he can retain the profits but competitive pressures and the run for higher market share ensure that some of the gains are passed on to consumers.

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