Deflation impacts consumers positively in the short term but negatively in the long term. In the short term, deflation essentially increases the purchasing power of consumers as prices fall. Consumers can save more money as their income increases relative to their expenses. This also alleviates debt burdens as consumers are able to deleverage.

While falling prices sounds like a good deal for consumers, the factors contributing to deflation are disastrous for consumers and the entire economy over the long term. There is a temporary lull when consumers' income remains steady while prices decline. Eventually, the falling prices begin to affect companies that are forced to slash pay and employment in response to falling revenue. This results in incomes declining and consumer confidence sliding.

This leads to decreased spending, which further pushes firms to cut prices to sell their products. Further, deflationary environments create incentives for consumers and businesses to put off spending money in expectation of falling prices. This rational behavior, on an individual level, feeds into economic weakness, as consumption is a primary driver of economic activity.

During these environments, debt loads and interest payments remain constant. They do not decline despite decreases in incomes. On a relative basis, these are actually increasing and eating up larger portions of household budgets. Many consumers are forced into bankruptcy during these environments and lose any assets that are purchased on credit, such as stocks, homes or automobiles.

Consumers on fixed incomes or those who are fortunate enough to not lose employment or have their pay cut may not face these difficulties. Nevertheless, they will be part of an environment in which their neighbors will be suffering and businesses will be shutting down. The Great Depression is the last time when the world faced entrenched deflation that persisted for years. This experience has taught central banks the necessity of fighting deflation at all costs.

  1. What causes negative inflation or deflation?

    Find out what deflation is, what causes it, how it hurts the economy and how it can lead to a worsening cycle of deflation ... Read Answer >>
  2. Were there any periods of major deflation in U.S. history?

    Learn about major periods of price deflation in the United States, particularly in the 19th century, when falling prices ... Read Answer >>
  3. What is the difference between deflation and disinflation?

    Learn what deflation and disinflation are, the differences between them, and how supply and demand affect price levels. Read Answer >>
  4. Which economic factors most affect the demand for consumer goods?

    Understand how key economic factors such as inflation, unemployment, interest rates and consumer confidence affect the level ... Read Answer >>
  5. Is the consumer price index (CPI) the best measure of inflation?

    The CPI is a sound index to measure inflation, but for a more accurate and comprehensive measure, the PPI and the GDP deflator ... Read Answer >>
Related Articles
  1. Insights

    Can Deflation Be Good?

    General economic theory consensus rules that deflation is bad for the economy. But the Swiss economy is growing despite a drop in prices.
  2. Insights

    Why Is Deflation Bad for the Economy?

    Deflation can adversely affect the economy in significant ways.
  3. Insights

    How the Eurozone's Fight Against Deflation Is Hurting Savers

    The European Central Bank is fighting a desperate battle against deflation. Find out what it is doing and how it is going to affect savers.
  4. Investing

    Inflation and Deflation: Keep Your Portfolio Safe

    Inflation and deflation are opposite sides of the same coin. When both threaten, here's how to construct your diversified portfolio to keep it safe.
  5. Insights

    The Dangers Of Deflation

    We look at what life would be like in a deflationary environment, and what you can do to protect your investments.
  6. Insights

    Americans Would Save $2.2 Billion If They Did All Their Shopping Online

    Deflation is not as bad as it sounds: just ask online shoppers.
  7. Financial Advisor

    Where to (and Not) Invest Based on Consumer Trends

    It's a volatile market, but picking winners and losers can be easier if you pay attention to consumer trends.
  8. Investing

    A Leveraged Oil ETN For The Future (Just Not Now)

    VelocityShares 3x Long Crude Oil ETN has the potential for huge returns, but there are several reasons why you might want to steer clear for now.
  9. Investing

    The Lost Decade: Lessons From Japan's Real Estate Crisis

    Find out what America can learn from Japan's liquidity trap and credit crunch.
  10. Investing

    Should You Invest Your Entire Portfolio In Stocks?

    Learn if investing your entire portfolio in stocks is a sound decision. Get information about important considerations.
  1. Value Deflation

    Value deflation happens when companies reduce the size or quality ...
  2. Purchasing Power

    Purchasing power is the value of a currency in terms of the goods ...
  3. Income Effect

    The income effect is the change in demand for a good or service ...
  4. Consumer Interest

    Consumer interest is any interest charge on personal loans, including ...
  5. Consumer Goods

    Consumer goods are the products purchased by the average consumer. ...
  6. Inflation

    Inflation is the rate at which prices for goods and services ...
Trading Center