Deflation

Financial Dictionary -> General Finance -> Deflation

Deflation (the opposite of inflation) in economics refers to an increase in the spending power of a country's currency. In other words after deflation $1 can buy more than it did a few years ago. This is reflected by a decrease in prices.

It is misleading to suggest that deflation is simply when things get cheaper, because in a stable economy as products and services decrease in price, the level of wages also generally decrease in an equal ratio meaning consumers can still only buy the same amount of items, it just takes less physical money. For example:

A loaf of bread costs $1 and milk costs $2
Eric gets $5 a day (poor guy) and buys his bread and milk, leaving him with $2.
After deflation a loaf of bread costs $0.50 and milk costs $1
However Eric's wage has been decreased to $2.50 per day. After he buys his bread and milk he's left with $1.
Eric is no better off than before deflation.

There is an overlap period. It takes a while for wages to catch up, meaning there may be a spike in consumer spending during this overlap period.

Deflation however is not necessarily a good or neutral thing. It often occurs after a reduction in the money supply and availability of credit, which in turn usually comes from a recession. The fall in prices is a natural way to get consumers spending again but this doesn't happen right away. It is therefore fair to say that around the time of deflation consumer spending is down (there is less demand for products). So businesses output is down (they may downsize); this means more unemployment .So generally as prices fall so does everything else. Eventually after a period of deflation things will climb back up.