Deflation, in simple terms, is the decline in the prices of products and services due to reduced demand. As companies chase limited demand at lower prices, it may rise further. For consumers, lower prices seem to be a benefit, especially after prolonged inflation or stagnant or declining wages.
In a deflationary environment, those who borrowed money from lending institutions are now unwilling (or unable) to repay the money they borrowed. In addition, stocks, bonds, and real estate that will not appear on the market in an inflationary environment may be lower than their actual value. For this reason, the Fed has been using monetary policy to fight inflation, taking into account the fear of deflation. (Also take a look: How does the Federal Reserve make monetary policy.)
The last time the US economy suffered a prolonged period of deflation was during the Great Recession, which officially lasted from December 2007 to June 2009, and the subsequent global recession in 2009.Prior to this, there was a long period of deflation during the Great Depression. The economy has experienced textbook deflation, and output and price levels have fallen sharply. During the period 1928-33, the US GDP declined every year, and other countries experienced similar declines due to the global connection with the US economy.Canada and Germany have also experienced their own forms of deflation.Since then, there have been only brief periods of price declines in the United States, such as the Great Recession, and these periods have not been generally accepted as systemic deflation. (Also take a look: What is the Great Depression?)
Deflation brings a bad stigma, and every time the direction of interest rates changes, it is likely to trouble the Fed. One of the main problems with the theory of the negative effects of deflation is that there is really not much historical data on this topic. When empirical studies are based on long-term observations of multiple events to be studied, they have greater credibility. In modern history, there is only one, maybe two. During a substantial deflation period, it is not easy to consider the potential positive effects of deflation.
Not all deflation is bad
Consider this hypothetical but feasible case: the economy has experienced a long period of exponential technological innovation-fierce price competition dominated by low-priced retailers, followed by long-term cheap capital leverage, and relatively loose lending standards. This situation may lead to a continuous increase in the supply of goods, because their manufacturing costs are getting lower and lower, and the supply of products available to consumers and suppliers exceeds demand. Judging from this information alone, this deflationary situation seems to be a good thing for consumers: cheaper products, more varieties and more suppliers to provide them with services. This brings us back to the inability to study the problem of modern deflationary periods, and can even show that the deflation experienced during the Great Depression may be an anomaly.
Worries about deflation are often confused with temporary price drops. Although deflation is characterized by a continuous decline in the consumer price index or the composite index of gross domestic product, the US economy is much more complicated than it was in the 1920s and 1930s. External influences on core commodities will affect prices and maintain unnatural low or high levels. Hedge funds, wars, and demand trends all put pressure on a commodity, which affects the entire economy. This is why deflation is difficult to predict, difficult to define, and almost impossible to verify until it begins or almost passes. This also makes it difficult to determine whether it is actually all bad. (Also take a look: The consumer price index is the friend of investors.)
The consensus among policymakers and economists is that the threat of deflation is a problem in itself. The amount of data available for research is limited, and the nature of deflation itself is somewhat vague. These are just a few obstacles to studying its impact. It is possible that, like a swinging pendulum, the deflationary environment will temporarily pause before swinging in another way. This may be the reason for such a large gap between deflationary periods, and it may also explain why they seem to be almost non-existent these days. Or maybe policymakers are just doing a good job of stopping the cycle. Either way, deflation may be a normal part of our economic cycle, not always so bad. (Also take a look: Maybe recessions and depressions are not that bad.)