Deflation Definition

Deflation Definition

Deflation is defined as a decrease in the general price level.

  • It is a negative inflation rate.
  • Deflation means the value of money will increase.
  • Deflation is often associated with periods of negative or stagnant economic growth (Great Depression, Japanese economy in 1990s, early 2000s). In fact deflation is often used to express a declining economy

AD AS Diagram Showing Deflation

https://www.economicshelp.org/images/macro/fall-AD.jpg

deflation

Deflation is considered harmful to economy because

  1. People delay spending, hoping prices will be cheaper next year
  2. Workers resist nominal wage cuts, therefore, real wages rise causing real wage unemployment.
  3. Real interest rates become too high. Even interest rates of 0% cannot induce people to spend creating a liquidity trap.
  4. Deflation increases the burden of debt

Deflation caused by rising AS

However, if deflation is caused by rising productivity, improved technology and lower costs, the deflation may not be harmful but beneficial.

https://www.economicshelp.org/images/macro/LRAS-increase.jpg

 

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