Deflation

From NYT.


``Everybody likes low prices. But deflation, the falling of prices throughout an economy, is not a good thing. It only enters the picture in bad times, as a threat to make things worse.

While inflation erodes the value of money, which progressively buys less and less per unit, deflation makes money worth more. That makes people and businesses less likely to spend it -- consumers because they expect even better deals if they wait, and businesses because it's less profitable to produce goods or services that will bring a lower real return. These factors can feed on each other to produce a downward economic spiral, as happened in the Great Depression.

The global economic downturn that began in 2008 has brought new worries about deflation, particularly in Europe. In April 2010, prices fell in Ireland and inflation was under 1 percent in five other eurozone countries, well below the official inflation target of 2 percent. A growing number of economists faulted the European Central Bank for what they saw as an inflexible fixation on fighting inflation. Unlike the Federal Reserve or the central bank in Japan, the European Central Bank has taken limited steps in expanding the money supply to counteract the drying up of bank loans.

In the spring of 2010 the Federal Reserve was confident enough about the recovery's strength that it started to make plans to undo some of the vast bond purchases that it had used as a way to pump money into the economy. But by June signs of new weakness led Fed policymakers to discuss the threat posed by deflation.

In August, the Fed's Open Market Committee announced that it would hold its balance sheet steady rather than wind it down, by using the proceeds from its huge mortgage-bond portfolio to buy long-term Treasury securities. While the central bank held off on taking more aggressive steps, like a new, huge round of asset purchases, it left open the possibility that additional easing of monetary policy could take place in the fall if the recovery were to continue to weaken.


This is how the Canadian government's Canadian Economy site defines deflation:

"Deflation refers to a persistent tendency, over an extended period of time, for prices and incomes to decline. If deflation persists, businesses may shut down or reduce their production. As a result, unemployment may increase and wage rates may fall. The spiraling effect of deflation on prices and wages may create pessimism, and the economy could fall into a recession."

Or as a 1982 headline in The New York Times put it, as prices rolled back briefly as a steep recession ended an era of inflation: "INFLATION HURTS, BUT DEFLATION COULD BE WORSE."

Many economists regard deflation as more dangerous than inflation, because it prompts consumers to delay purchases as they wait for lower prices, creating a downward spiral of lower demand and production. Deflation is also bad for debtors, because they may have to pay back money that would be worth more than it was when they borrowed it.

During the Great Depression, prices fell by as much as 20 to 30 percent in many countries, in a process that was both caused by and contributed to the downward economic spiral. Since then prices almost everywhere have marched almost invariably upward, with the main danger being cases where it rose too fast.

The great exception was Japan, during what came to be known as its "lost decade.'' A gigantic real-estate boom in the 1980's came crashing down in 1991, bringing many other prices with it. Efforts to restart the economy foundered time and again, as businesses were not able to generate the kind of profits that would reignite prosperity's cycle of hiring and spending. Not until 2005 was the deflationary era finally declared to be over.''