Deflation - the opposite of inflation - is typically characterized by a persistent decline in prices. While on the surface this may seem to be good news, it is not. The cause for deflation is a long-term drop in demand - falling price levels, contracting money supplies, and a decline in output, employment, and income in a continuing downward spiral. A sustained downward spiral in prices of goods over a period of time is indicative of an economy in recession.

The term “Deflation” should not be confused with “Disinflation” which is a slowdown in the rate of inflation – though the inflation is positive, it is steadily declining over time.

The Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics (BLS) of the U.S. Department of Labor, measures changes in the price paid by urban households for  a broad basket of consumer products and services. The percentage change in this index is an indicator of inflation or deflation.

Is deflation good or bad? The answer depends on the circumstances in which it occurs. Lower prices due to an increase in supply of goods are generally good news for consumers. A good example of this would be the Industrial Revolution of the late 1800s that led to increased production.  Deflation becomes bad when falling prices are associated with falling wages, rising unemployment and falling asset prices. For example, during the Great Depression, deflation reflected economic collapse and rising unemployment.

Once it is well entrenched, deflation is very difficult to tackle. It feeds into a vicious cycle of people that are unwilling to spend, reducing demand, continuously falling prices, businesses closing down and lost jobs, which in turn forces people to reduce spending, thus egging the cycle on and on. The most common way to fight fears of deflation is for the Federal Reserve Bank to increase the supply of money by lowering the interest rates encouraging banks to borrow more and lend lower rates.