deflation of Money

Deflation is a fall in the overall level of prices in an economy and an increase in the purchasing power of the currency. It can be driven by an increase in productivity and the abundance of goods and services, by a decrease in total or aggregate demand, or by a decrease in the supply of money and credit.

Deflation: Causes and Effects

If, as the common saying goes, inflation is the result of too much money chasing not enough goods in the economy, then conversely deflation can be understood as a growing supply of goods and services being chased by a constant or slower-growing supply of money. This means that deflation can be brought about either by an increase in the supply of goods and services or by a lack of increase (or decrease) in the supply of money and credit. In either case, if prices can adjust downward, then this results in a generally falling price level.  

An increase in the supply of goods and services in an economy typically results from technological progress, the discovery of new resources, or an increase in productivity. Consumer’s purchasing power increases over time and their living standards rise as the increasing value of their wages and business incomes allow them to purchase, use and consume more and better quality goods and services. This is an unambiguously positive process for the economy and society as a whole.

At times some economists have expressed fears that falling prices would paradoxically reduce consumption by inducing consumers to hold out or delay purchases in order to pay lower prices in the future. However, there is little evidence that this actually occurs during normal periods of economic growth accompanied by falling prices due to improvements in productivity, technology or resource availability

The Bottom Line

A little bit of deflation is a product of, and good for, economic growth. But, in the case of an economy-wide, central bank fueled debt bubble followed by debt deflation when the bubble bursts, rapidly falling prices can go hand-in-hand with financial crisis and recession. Thankfully, the period of debt deflation and recession that follows is temporary, and can be avoided entirely if the perennial temptation to inflate the supply of money and credit in the first place can be resisted. 

All in all, it is not deflation, but the inflationary period that then leads to debt deflation that is dangerous for a country's economy. Perhaps unfortunately, consistent and repeated inflation of these kind of debt bubbles by central banks has become the norm over the past century or so. At the end of the day this means that while these policies persist, deflation will continue to be associated with the damage they cause to the economy.

KEY TAKEAWAYS

• Deflation is when the general price levels in a country are falling—as opposed to inflation when prices rise.
• Deflation can be caused by an increase in productivity, a decrease in overall demand, or a decrease in the volume of credit in the economy.
• Most of the time, deflation is unambiguously a positive trend for the economy, but it can also under certain conditions occur along with a contraction in the economy. 
• In an economy dominated by debt fueled asset price bubbles, deflation can lead to a temporary financial crisis and period of liquidation of speculative investment known as debt deflation.