What is deflation and why is it a worry?

  • Occurs when the inflation rate falls below zero, i.e. prices start falling.
  • Ok when it reflects technological/productivity progress that creates significant economic growth e.g. China in late 1990s (in such cases interest rates can be lowered to increase demand).
  • Problematic when it reflects oversupply (e.g eurozone right now - where demand is so weak it can't match production, and interest rates are near zero) as can lead to deflationary spiral, i.e. people delay spending as they expect lower prices in the future, so demand falls, so growth falls, so prices drop more etc...
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