What is deflation?

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DEFINITION:

Deflation is the decline in the price of goods and services over time, resulting in an increase in the purchasing power of a currency.

Understanding deflation

Deflation occurs when the inflation rate is negative. It occurs when consumer prices fall across the board. A decline in prices and subsequent deflation are usually the result of a decline in consumer spending and lower demand for products and services. Deflation leads to an increase in the purchasing power of money. While many consumers see this as a good thing, deflation can indicate a recession or economic instability. A recession usually means lower wages, fewer jobs, and a decline in the stock market. The Consumer Price Index (CPI) is responsible for measuring inflation and deflation rates.

EXAMPLE

The most significant real-world example of deflation in recent history occurred during the Great Recession that began in 2007. By 2009, the inflation rate had fallen below zero, which meant that the country was experiencing deflation. This deflation was accompanied by an unemployment rate of over 10 percent, the highest level the country had experienced in more than 20 years.

Takeaway

Deflation is like a bad cough…

A cough is a symptom of a disease, but it is not the disease itself. Likewise, deflation is a sign of a larger problem in the economy. Deflation is a symptom of a disease, but it is not the disease itself.

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