What Is Deflation?

Deflation is a sustained decrease in the general level of prices for goods and services. It is the opposite of inflation. When deflation occurs, the purchasing power of money increases -- your dollars buy more over time. While that sounds appealing, economists generally consider deflation more dangerous than moderate inflation.

The danger of deflation lies in the "deflationary spiral." When prices fall, consumers delay purchases (why buy today if it's cheaper tomorrow?). This reduces demand, forcing businesses to cut prices further, lay off workers, and reduce investment. Unemployment rises, incomes fall, and spending drops even more -- creating a vicious cycle that can be very hard to break.

The most famous example of deflation is the Great Depression of the 1930s, when U.S. prices fell roughly 25% over four years. More recently, Japan experienced a "Lost Decade" of deflation from the 1990s through the 2000s, resulting in stagnant economic growth for over 20 years.