Deflation

Economics.

A situation in which prices generally are falling.

In other words, inflation is negative.

Central banks are generally tasked with aiming to ensure a small positive rate of inflation, and to steer the national economy away from deflation.

How deflation can lead to recession

"What would you do if you knew the £100 bike you wanted to buy today, was going to be reduced to £90 tomorrow?

You would probably wait to buy it for the cheaper price.

When prices begin to fall, people expect they will continue to go down.

This expectation results in people spending less today, in hope of buying at a cheaper price tomorrow.

This is bad for businesses.

If prices fall, businesses are likely to make less profit.

Businesses don’t like to see their profits fall, so they will try to do something about it.

Let’s go back to that bike you wanted to buy.

The owner of the bike shop is now getting £10 less for each bike and so may try to cut costs to make up for this loss.

This is where deflation can negatively affect employees.

Businesses’ biggest cost is usually staff.

To reduce staff costs, businesses have two options: to cut wages or staff numbers.

In other words, deflation could lead to you losing your job.

If prices fall on a large scale, then there may be many job losses.

People typically spend less when their incomes fall, so they might not be able to afford the bike at £90.

So now, the business could be forced to cut prices further in order to sell anything at all.

This creates a spiral effect as prices need to be reduced again and with falling income, comes unemployment if businesses can no longer afford to keep workers.

This spiral of falling prices and unemployment is often associated with a recession."

Bank of England - What is deflation?

See also

• Central bank
• Depression
• Hyperinflation
• Inflation
• Lowflation
• Recession
• Stagflation

External link

Bank of England - What is deflation?