Deflation is an economic phenomenon characterized by a sustained and general decline in the overall price levels of goods and services in an economy. In other words, you can buy more goods and services over time with the same amount of money.
Deflation occurs when the supply of goods and services exceeds the demand for them, leading to reduced prices. This can be caused by various factors, such as a decrease in consumer spending, reduced business investment, or an economic recession. Deflation can also be triggered by technological advancements that increase productivity and lower production costs, leading to lower prices for goods.
While deflation may sound beneficial as it increases consumers' purchasing power, it can have negative economic consequences. One major concern is that deflation can lead to a deflationary spiral. As prices fall, consumers may delay purchases, expecting even lower prices in the future. This reduction in consumer spending can lead to lower demand, further decreasing prices, and creating a self-reinforcing cycle of falling prices and economic stagnation.
Deflation can also hurt borrowers because the real value of their debts increases over time, making it more challenging to repay loans. It can also lead to reduced profits for businesses, which may result in layoffs and lower wages.
Central banks and policymakers often aim to prevent deflation or mitigate its effects by implementing expansionary monetary policies, such as lowering interest rates, and adopting fiscal measures to stimulate demand and economic activity. In contrast, moderate inflation is typically targeted as it encourages spending and investment while preserving the stability of prices and the overall economy.