Deflation is the opposite of inflation and is defined as a persistent fall in the average level of prices in an economy.
Deflation is generally seen negatively, as it suggests a fall in aggregate demand leading to a fall in the average price levels; which further results in an increase in unemployment.
Alternatively, deflation can also be caused by increased productivity of firms, which increases the supply without a linear increase in demand.
If the supply goes up, but demand remains fairly constant, the average price level will decrease, to reach equilibrium where demand = supply.
Deflation has several positive and negative impacts.
It can certainly be good for the economy in the short-term, as it leads to consumers having increased purchasing power. In deflation, £1 is able to buy more than in inflation. This is because as the average price levels falls, people’s wages have more value.
This increased spending, if significant enough, can boost the economy.
However, during periods of deflation, wages are generally reduced and more people are likely to become unemployed – therefore, increased purchasing power is only a short-term benefit.
In the long-run, deflation causes a fall in demand, and therefore, consumption levels are likely to decrease.
This can be seen as a positive impact because in the world, where we are rapidly running out of resources (such as oil) due to excessive consumption.
A deflationary economy might be of a benefit in helping the world to reduce the problems of over-consumption.
It can also be good for the environment – as it has been proven that over-consumption can be a key factor leading to pollution, global warming etc.
However, deflation is good for the economy only to a very small extent.
Generally, it brings a lot of negative impacts.
One of these is the rise in unemployment. As deflation is a fall in the average level of prices and a decrease in aggregate demand, firms have to lower their costs to sustain previous revenue.