Prices falling across the board:cash buys more, but growth is floored.
A sustained decrease in the general price level of goods and services.
Deflation increases a currency’s purchasing power but can signal economic weakness, often prompting central banks to lower interest rates.
In plain words
Deflation is a sustained fall in the general level of prices across an economy, the opposite of inflation. Each unit of money buys more than it did before. It is different from a fall in the price of a few goods, and from disinflation, which is inflation slowing down while prices still rise.
See it move
Spending delayed, then Sales weaken
Why it matters
Falling prices can lead households and firms to delay spending, and they make debts heavier in real terms, so central banks generally respond by lowering interest rates or easing policy in other ways. Those policy expectations are what link deflation to exchange rates.
Worked example
An example only. The figures are round and invented for the arithmetic: they are not market prices.
A basket of goods costs 100 at the start of an invented year, prices fall 2% over the year, and a borrower owes 1,000 throughout.
- 1Basket at the end of the year = 100 × 0.98 = 98
- 2Debt at the start, in baskets = 1,000 ÷ 100 = 10
- 3Debt at the end, in baskets = 1,000 ÷ 98 = about 10.2
Money buys about 2% more, and the unchanged debt has become about 2% heavier when measured in goods.
A common mistake
Falling prices sound like good news for everyone. A sustained general fall tends to come with weak demand, and it raises the real burden of debt.
Check yourself
Educational information, not investment advice or a recommendation to trade.