Q:

Why is deflation bad for the economy?

A:

Quick Answer

Deflation is bad for the economy because it causes delayed spending, nominal wage cuts, higher interest rates and a higher burden of debt ratio. Deflation is the opposite of inflation and generally causes prices to go down after a recession.

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Full Answer

While inflation is a serious issue, many economists consider deflation to be more serious because it is more difficult to control. At first glance, deflation seems like a great thing because it means prices are going down. However, as deflation drives prices down, profits and production decrease. The decrease in profits and production drives wages lower. In more extreme cases, employees are laid off because wages cannot be driven lower.

In addition, unemployment rates rise and people are reluctant to spend their money because the future of the economy is questionable. Furthermore, due to the questionable future of the economy, investments are sold. As more consumers are reluctant to spend their money and build their savings by selling their investments, interest rates plummet. Most importantly, the central bank is forced to evaluate its currency and adjust to the impact of deflation.

Since deflation is a result of inflation, the government attempts to guide the public to spending less and saving more by raising interest rates in times of inflation.

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