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Definition of Deflation:

Deflation is the decrease in the price level for goods and services and an increase in the value of money.

Detailed Explanation:

Economists fear deflation. Deflation is most common during severe recessions or depressions. When prices are falling, consumers may delay purchasing goods and services, hoping to pay less if they wait long enough. Why buy something today when it will cost less tomorrow? Businesses may delay investing in equipment until the equipment prices fall and consumers resume purchasing their product. These behaviors discourage economic growth and may exacerbate a recession, which is why most economists favor moderate inflation over deflation. However, during periods of disinflation consumers and businesses continue to have an incentive to buy in the present to avoid higher prices in the future.

Deflation must not be confused with disinflation. Disinflation may be the desired result of monetary policy when a central bank wants to reduce the inflation rate. Disinflation is a slowing of the rate of inflation. Unlike deflation, prices continue to rise during disinflation, but less than in the prior period. For example, if January’s inflation rate equaled one percent, and February’s inflation equals negative 0.25%, deflation occurred, but if the inflation rate fell to 0.25%, disinflation occurred. 

Deflation occurred during the Great Depression when prices dropped approximately 30 percent. It took a war and over a decade for the United States to emerge from the depression. More recently, Japan experienced an extended period of deflation and severe recession in the 1990s. Japan still has yet to return to the robust economy it had in the 1980s. However, in the US, disinflation was prevalent between 1990 and 2020, when inflation dipped to its lowest level in nearly half a century.

inflation rate chart

Source: Bureau of Labor Statistics

Dig Deeper With These Free Lessons:

Causes of Inflation
Gross Domestic Product – Measuring an Economy's Performance
Monetary Policy – The Power of an Interest Rate
Business Cycles

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