Deflation

The Great Depression and Japan's more recent experience convinced some central bankers that deflation is dangerous. This report, however, argues that deflation is an acceptable economic outcome if it is occasional, small in magnitude, and accompanied by strong productivity growth. They analyze the economic impact of deflation and conclude that while the zero, or very low, nominal interest rates that often accompany deflation can cause problems, many of the problems attributed to deflation are not unique to falling prices per se. Some business people mistakenly fear deflation when the real issue is the decline in the price of the goods and services they produce relative to other prices. Furthermore, some of the disruptions attributed to deflation arise not because the price level is falling but because prices are rising more slowly than anticipated. A better understanding of the dangers of deflation is especially pertinent in light of modern central banks' near-universal commitment to low inflation and their increasing use of inflation targeting as an operational framework.