Deflation is defined as a decrease in the general price level.
It is a negative inflation rate.
Deflation means the value of money will increase.
Deflation is often associated with periods of negative or stagnant economic growth (Great Depression, Japanese economy in the 1990s, early 2000s). In fact, deflation is often used to express a declining economy.
People delay spending; hoping prices will be lower next year; this causes further falls in aggregate demand and rate of economic growth.
Workers resist nominal wage cuts. Therefore, real wages rise causing real wage unemployment.
Real interest rates become too high. Even interest rates of 0% cannot induce people to spend creating a liquidity trap.
Deflation increases the burden of debt and reduces the disposable income of indebted people.
Deflation can become entrenched in the economy – causing sluggish rates of economic growth.
However, if deflation is caused by rising productivity, improved technology and lower costs, the deflation may not be harmful but beneficial.
This shows how a shift in SRAS to the right causes lower price level.
Between 1920 and 1936, the UK had a prolonged period of deflation, with the inflation rate rarely rising above zero.