What is deflation? In economic terms, deflation is defined as a decrease in the average price level of goods and services or an increase in the purchasing power of the standard unit of currency. It might be easier, however, for most to just think about deflation as a negative inflation rate (below 0%).
What this means for the average consumer is more buying power with their money. It will require less money to purchase the same amount of goods or services than it did before.
Like inflation, deflation in the United States is measured using the consumer price index (CPI). The average price of hundreds of items throughout the country are collected and compared to results from previous surveys. If that average equates to a decline from previous results, we are said to be in a deflationary period.
While this may sound good to many, it is generally not considered desirable by most economists. Prolonged periods of deflation can result in a recession.
As sellers receive less money for their products, they are forced to cut their costs. Doing so might result in lay-offs, or other cost-saving measures. This tends to create a downward spiral in the economy as more and more people are affected in the chain by the cost-saving moves. In turn, they are also spending less. As can be imagined, an extended period of deflation results in higher levels of unemployment.
Throughout history, however, this has not always been the case. At times, deflation can be the result of improvements in sectors such as manufacturing. If productivity can be improved, the cost of goods can be lowered. For instance, in the late 1800’s in the United States, there was a prolonged period of deflation. This was caused by manufacturing improvements and lowered transportation costs resulting from the technological revolution of the era.
One more related term to keep in mind is disinflation. It sounds as if it would be the exact same as deflation, but it is not. Whereas deflation is the negative of inflation, disinflation is just a slowing of the concept. For example, if inflation has been averaging 3% for the last ten years, but then decreases to only 1% this year, inflation is still occurring, but at a slower rate. This is disinflation.
As with inflation, deflation can be combated through many measures. The most common of which is utilized by the government through fiscal and monetary policy changes.