Deflation is the persistent fall in prices in an economy in a year, the complete opposite to inflation, and occurs when the inflation rate is negative.
Demand-side deflation, also known as bad deflation, occurs when aggregate demand shifts to the left.
Supply-side deflation, also known as good deflation, occurs when aggregate supply shifts to the right.
Demand-side deflation can be very bad for the economy as it can lead to lower economic growth and a major issue is that it could be long-term and anticipated.
Supply-side deflation is more likely to be short term and unanticipated.
Unanticipated deflation is beneficial in the short term but can be dangerous in the long term as it could lead to a deflationary spiral.
Rational consumers are likely to delay their spending in anticipation of further price falls, which can lead to a deflationary spiral.
Businesses are likely to slow their prices or discount in anticipation of further price falls, which can make deflation even worse.
The deeper consequence of deflation is not just a deflationary spiral, but continually happeningdeflation can lead to lower growth and higher inflation.
Unemployment can have horrible consequences for the economy.
Due to the deflationary spiral, lower growth and higher unemployment can result.
Interest rates can only really fall to 0% so even if the central bank cuts interest rates to 0% to stimulate the economy and promote more inflation, interest rates will always be positive in real terms.
From the demand side, deflation can be very dangerous, but if it's short-term and not anticipated, it can be beneficial for consumers and businesses.
If interest rates are zero percent nominal, the real interest rate is the nominal interest rate minus the inflation rate.
When there is deflation, real interest rates will always be positive.
Real interest rates are the nominal interest rate minus the inflation rate.
If deflation is two percent, the real interest rate is minus two percent.
From the supply side, deflation can be beneficial if it's anticipated and long term, but if it's unanticipated and short term, it can be problematic for businesses.
If profits and incomes are falling, it makes it harder to service debt, increasing the real value of debt.