What Is Deflation?

Deflation is a decrease in the general level of prices for goods and services – this is in contrast with inflation, which is an increase in the general price level. Deflation is caused by an increase in the purchasing power, which is a result of an increase in the amount of money in circulation, or from increased productivity. Deflation occurs when there is an increase in the available supply of goods and services, while the demand for those goods and services drops.

Effects of Deflation

The effects of deflation are both positive and negative. On one hand, it can lead to lower prices and increased consumer purchasing power. This can be beneficial for households and businesses as they can buy more with the same amount of money, helping to increase savings and purchasing power. On the other hand, deflation can lead to higher unemployment as businesses may not have the sufficient demand to justify increasing production. It can also lead to lower profits for businesses that rely on sales of goods and services.

Examples of Deflation

One of the most recent examples of deflation was the 2008-2009 financial crisis when prices for goods and services fell across the global economy. We saw a decrease in consumer spending and businesses had to reduce production due to the lack of demand for goods and services. Another example of deflation comes from Japan in the 1990s when the economy confronted a decade of deflation as a result of the bursting bubble of its asset prices like stocks and land values.

How to Combat Deflation

One way to combat deflation is through expansionary monetary policy, whereby the central bank increases the money supply and reduces interest rates, which can increase investment and spending. Expansionary fiscal policy can also be used, where the government increases spending and reduces taxes in order to stimulate consumer spending and business investment. The combination of both fiscal and monetary policy is often used in order to effectively address deflation, as well as other economic problems.