Deflations

Deflation is a sustained decrease in the general price level of goods and services in an economy, typically measured by price indices such as the consumer price index or the GDP deflator. It differs from disinflation, which is a slowdown in the rate of inflation but does not produce negative inflation.

Causes and mechanisms of deflation include weak aggregate demand, improvements in productivity that lower costs, and monetary conditions that tighten credit. A classic explanation is debt-deflation: when prices fall, the real value of debt rises, prompting households and firms to cut spending and reduce borrowing, which further reduces demand and pushes prices lower.

Economic effects of deflation can be adverse. It can lower consumer spending as people delay purchases in anticipation of even lower prices, raise the real burden of debt, increase real interest rates, and depress investment and employment. If deflation becomes entrenched, expectations of falling prices can create a deflationary spiral that is difficult for policymakers to reverse.

Measurement and historical context: Deflation is identified when the general price level declines over a period. Historic episodes include the Long Depression of the late 19th century, the Great Depression of the 1930s, and Japan’s prolonged period of near-zero or negative inflation starting in the 1990s. Occasional deflationary episodes have occurred in other economies during financial distress.

Policy responses and considerations: Central banks can counter deflation with monetary easing, including lower policy rates, asset purchases, and forward guidance, while governments may use fiscal stimulus or debt relief to support demand. When rates approach the zero lower bound, unconventional measures and credibility of price stability become crucial.