Deflation

published 27 May 2018

Deflation is the word used to describe falling prices. These are not necessarily a bad thing. They can, for example, be caused by rising productivity or reduced costs in an industry. But a period of sustained nationwide deflation can be very destabilising.

If consumers feel that prices are likely to fall over time, they tend to delay purchases (they hold cash with the expectation of being able to purchase the same goods at a lower price later). This pushes down corporate profits which, in turn leads to cost cutting and unemployment, which then reduces consumption further.

Deflation is also bad for borrowers contractually committed to making cash repayments. As prices fall, the real value of debt rises, making it much harder to pay back (prices and your wages may be falling, but the debt stays the same).