Deflation is a decline in the general level of prices in an economy. It is the opposite of inflation, in which prices rise. Deflation is rarer than inflation, but its consequences can be more severe.
Each year, about 5 percent of all countries experience deflation. Most of them are less developed nations, and the deflation they experience is brief. However, many industrialized countries, including the United States, the United Kingdom, Japan, Australia, and Canada, have experienced periods of deflation.
Deflation sometimes occurs when an economy undergoes a depression or a recession. During depressions and recessions, the total output of an economy declines. Depressions are more severe than recessions. The United States experienced sharp deflation during the Great Depression of the 1930′s.
Deflation can be caused by competition among producers of goods and services to increase sales by reducing their prices. But weak demand for goods and services is the chief cause of almost all periods of deflation. In the United States during the Great Depression, several forces acted simultaneously to reduce demand. Banks had little money to lend to qualified individuals and businesses. The Federal Reserve System, the nation’s central bank, failed to stimulate the economy by increasing the amount of money in circulation. Also, the federal government sought a balanced budget, which prevented it from cutting taxes or increasing its own spending. All of these factors contributed to a decline in demand and thus to deflation.