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?