Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.
Deflation makes the cost of leverage significantly higher. Deflation is commonly associated with a contraction of credit and general monetary supply.
While the general public has a healthy concern for substantial inflation, even moderate deflation is significantly detrimental for a monetary system.
Why it Matters to You
For a company with leverage in a period of deflation, it is prudent to either close out debt at the onset of a deflationary cycle, or to pay the barest minimum throughout the cycle, as your dollar will count for very little against the principle.
In a deflationary cycle, prices and wages may need to be decreased, which carries numerous challenges. Transparency and clear communication are essential to navigating a period of deflation.