DEFINITION: Deflation denotes a decrease in the amount of money (nominal price) that must on average be paid for goods. It’s not deflation if Walmart puts an item up for sale, thus lowering its nominal price. It is deflation if all stores taken together lower prices on all goods. The opposite of deflation is inflation.
Deflation occurs when the supply of goods and services offered within an extended market system—nowadays, usually a nation state—increases more rapidly than the money supply. In that case, the nominal price of the goods and services will decrease over time until the gap is closed. This means that the purchasing power of each unit of currency increases.
Deflation must not be confused with disinflation, which is a decrease in the rate of increase of nominal prices—that is, a slowing of the rate of inflation.
Deflation, in contrast, signifies an absolute decrease in the value of a nominal price from some reference point as time goes by. To take a concrete example: If deflationary conditions are prevailing within a given market system, then a dozen eggs might cost, say, $2.00 today and $1.50 a month from today.
ETYMOLOGY: “Deflation” is derived from the Latin “de,” meaning “down,” “from,” or “out of” + “flāre,” meaning “to blow.”
USAGE: At first, deflation may sound like a good thing, but if it persists, it is a decidedly bad thing.
The reason is that the decrease in the price of goods and services represents a loss to the producer. Therefore, deflation may rapidly lead to recession, business failure, and ultimately economic depression.
For this reason, economists dread deflation far more than they do inflation.