Fears of deflation

Economists have been using the d-word — deflation — more frequently. Deflation means that prices are falling; what can be wrong about that? N.C. State University economist Mike Walden explains.

“Actually deflation is something greatly feared by economists. Deflation has been associated with some of our worst economic times and here is why:  If prices are falling, businesses are actually taking in less revenue. That means they don’t have as much money to pay their workers, so they are either going to dismiss them or pay them less. If the workers get paid less, then they feel as if they are poorer. They reduce their spending, and we get into this downward spiral where the lower prices lead to lower wages, leads to lower spending. And actually most of the times when we have had deflations, we have had really horrible depression.

“And one way can avoid this would be if everyone simultaneously adjusted their views of what money is worth, because with prices lower your money is worth more. But most people don’t do that. And so what we have to look for is to particularly the Federal Reserve to try to avoid deflation. And they can try to do this by simply printing more money. However, if people simply sit on that money and don’t spend it you could still have the deflation. So this is something we do have to watch out for in the near term.”