What is deflation?

Completely out of the blue, someone in my Year 12 economics set asked me what deflation is. Apparently, there had been some discussion of this in a politics lesson and it was throught a good idea to refer the question to the economists! How wise. Best not to trust the politicians when it comes to anything to do with prices.

All the talk for the last 10 years has been about bearing down on INFLATION - the sustained increase in the general level of prices. So, why should DEFLATION matter?

Deflation is a sustained decrease in the general level of prices. 'Great', you may say. If things are getting cheaper then surely that must be good news? Well, no. If prices are continuously falling, what's the point of buying now when you can wait for prices to drop even further? If we all think like this, then spending will drop. If spending drops, overall demand drops. As demand drops that affects output. If output falls, that means jobs are lost. Defaltion matters because it causes us to hang on to our money rather than spend it and that means prolonged recession.

My challenge

A reward for the best account of the problems of deflation with an illustration from the recent economic performance of Japan.

Useful weblinks

Article in the Independent

Reuters guide to deflation