Fears of deflation

Date posted: July 14, 2010

When most of us worry about prices, we are concerned about them going up — that is, we are worried about inflation. But should we also fear the opposite: prices going down?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

“It depends … on the cause of the prices going down. That is to say that there is good deflation and there is bad deflation. Good deflation results when the falling prices come from businesses being able to manufacture something more efficiently. So, for example, if you look at the price of — oh, let’s say — cell phones, they have actually come down quite a bit. And that’s because cell phone manufacturers have gotten better at being able to produce them more efficiently. And so that is good deflation.

“Bad deflation, though, results from when prices are going down simply because people are not buying and a business simply wants to get rid of its inventory, so they drastically cut their prices in order to hope to move that inventory. And bad deflation is usually associated with a recession. In fact, last year in 2009, we actually had deflation for part of that year.

“The other reason it is bad is it is usually tied to wages and salaries going down. We actually saw that last year.

“And then finally, bad deflation makes the value of debts that people have — because they pay those debts back in a set amount of dollars — makes those debts more expensive.”

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