What is deflation?
Prices falling across the economy — rarer than inflation, and more feared by the people who set interest rates.
Deflation is prices falling across the economy as a whole: the general price level moving down, month after month, rather than up. It is the mirror image of inflation. A discounted flight or a cheaper laptop is not deflation on its own — deflation means the average cost of goods and services across the whole economy is shrinking, and it tends to keep shrinking once it starts.
Why it is feared
Central banks generally treat deflation as more dangerous than moderate inflation, for a simple reason: falling prices reward waiting. If a washing machine will be cheaper next month, the rational move is to delay buying it. When enough people and businesses make that same calculation at once, spending slows, sellers cut prices further to attract buyers, and the delay becomes self-reinforcing.
That slowdown feeds back into the economy. Businesses selling into falling prices see revenue drop, so they cut costs, which often means fewer jobs or lower wages. Weaker household income reinforces the urge to postpone spending rather than reverse it.
Deflation also makes existing debts heavier in real terms. A loan agreed before prices fell still demands the same repayment, but wages and revenues used to service it are now shrinking. Borrowers who were comfortable can find the same repayment much harder to meet, which is one reason central banks aim to keep inflation low and positive rather than at zero or below.
Not to be confused with
Disinflation is inflation slowing down while prices are still rising overall — a smaller increase, not a fall. Deflation is the price level actually dropping.
A single market’s prices falling, such as electronics getting cheaper as technology improves, is not deflation either. Deflation describes the broad, economy-wide price level, not one sector moving against the trend.