Description
In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e., when inflation declines to a lower rate but is still positive.
Economists generally believe that a sudden deflationary shock is a problem in a modern economy because it increases the real value of debt, especially if the deflation is unexpected. Deflation may also aggravate recessions and lead to a deflationary spiral (see later section).
Some economists argue that prolonged deflationary periods are related to the underlying of technological progress in an economy, because as productivity increases (TFP), the cost of goods decreases.
Deflation usually happens when supply is high (when excess production occurs), when demand is low (when consumption decreases), or when the money supply decreases (sometimes in response to a contraction created from careless investment or a credit crunch) or because of a net capital outflow from the economy. It can also occur due to too much competition and too little market concentration.
Incidence
The world economy now displays a wide variety of symptoms indicative of strong deflationary pressures: (a) In real terms international interest rates remain high, both by past standards and compared to rates of growth; (b) Commodity markets remain glutted, with a tendency for prices to weaken even more. To the extent that inflation is negligible, further drops in commodity prices tend to widen profit margins and lessen aggregate spending, while increasing interest rates for debtors; (c) In many developed-market economies, unemployment rates remain extraordinarily high. Poor sales prospects are deterring firms from enlarging capacity despite higher profit margins. Consequently the use of labour and raw materials is especially sluggish; (d) Markets for numerous products, including some of the most advanced technologically, are slack; this is reflected both in price movements and in a variety of practices that further close up the trading system; (e) Export markets in developing countries remain depressed, denying sales top businesses in both developed and developing countries.