Deflation (Economics)

The decrease in general price levels, characterized by the rise in the value of money. This economic situation, often caused by the reduction [Page 138]in the supply of money or credit, leads to the fall in prices, wages, and credit. In addition to the decrease in the supply of money, deflation can be caused by a de crease in the demand for goods, an increase in the supply of goods, or an increase in the demand for money.

Deflation can be induced by contractions in overall spending and a decrease in consumer demand in a country as a result of a decrease in government spending, personal spending, or investment spending. Consequently, unemployment rises or salaries are cut, corporate profits fall or factories close. Often defaults on individual and company loans increase, and ultimately, the country enters into an economic recession or depression. To remedy an economy characterized by deflation, or to mitigate deflation, the Federal Reserve has the power to use a monetary policy to increase the money supply and induce rising prices, causing the opposite effect, or inflation.

Some economists believe that deflation is a purely monetary effect of government-enforced slimming of credit or increases in interest rates, which in effect increases unemployment. In some instances, the govern ment induces deflation by imposing interest rate increases and tightening the money supply to suppress inflation and slow the economy.

Deflation should not be confused with disinflation, which refers to the slowing rate of inflation or general levels of prices.