Definition
Deflation is a general and sustained decline in the prices of goods and services, the opposite of inflation. When an economy is in deflation, a fixed amount of money buys more over time, and a price index such as the CPI registers a negative change.
Although cheaper prices sound appealing, broad deflation is usually a symptom of economic weakness. It typically reflects collapsing demand, a contracting money supply, or a credit crisis rather than a healthy abundance of goods.
Why it matters
How it works
Deflation often begins when demand drops sharply. Firms cut prices to sell inventory, but consumers, expecting still-lower prices, postpone spending. Reduced sales lead to wage cuts and layoffs, which lower demand further. Meanwhile, the real burden of existing debt rises because loans must be repaid with money that is now worth more, forcing borrowers to cut back even more. This self-reinforcing loop, known as a deflationary spiral, makes deflation dangerous and difficult to escape once it sets in.