Deflation occurs when the general price level of goods and services in an economy declines over a sustained period, typically measured by a negative change in a consumer price index (CPI) or GDP deflator. It is distinct from disinflation, which describes a slowing rate of positive inflation.
Economists generally identify several causes:
- Demand-side deflation: a contraction in aggregate demand, often following a financial crisis, asset-price collapse, or fiscal tightening.
- Supply-side deflation: productivity gains or falling input costs (e.g., cheaper energy or technology) that lower prices without harming output.
- Debt deflation: a dynamic described by Irving Fisher in 1933, in which falling prices increase the real value of debt, forcing borrowers to liquidate assets, which depresses prices further.
- Monetary deflation: a contraction in the money supply or velocity of money.
While falling prices can benefit consumers in the short term, sustained deflation is widely considered harmful. It raises real interest rates, increases the real burden of debt, encourages households and firms to postpone spending and investment, and can push economies into a liquidity trap where conventional monetary policy loses traction at the zero lower bound.
The two most-cited historical episodes are the Great Depression in the United States (roughly 1929–1933, when prices fell by about a quarter) and Japan's "Lost Decades" beginning in the 1990s, during which the Bank of Japan struggled to escape mild but persistent deflation through near-zero rates, quantitative easing, and, after 2013, the "Abenomics" program under Prime Minister Shinzō Abe and BoJ Governor Haruhiko Kuroda.
Central banks today typically target low positive inflation (commonly around 2%) partly to maintain a buffer against deflation. The IMF, OECD, and central banks such as the ECB and the Federal Reserve monitor deflation risk closely, particularly during recessions and financial crises such as the 2008 global financial crisis and the early COVID-19 shock in 2020.
Example
Japan experienced prolonged deflation from the late 1990s into the 2010s, prompting the Bank of Japan under Governor Haruhiko Kuroda to launch large-scale quantitative easing in 2013 as part of "Abenomics."