Don't go too low

The opposite of inflation is deflation, or a steady decline in the general price levels of goods and services over time. While deflation might seem desirable, it’s actually bad for the economy as a whole. When general price levels fall, companies often have to keep lowering and lowering their own prices to stay competitive. This can lead to falling profits, reduced output, layoffs, and even business failures. Eventually, decreased demand and higher unemployment can lead to an economic depression.

Japan went through a long period of deflation in the 1990s and 2000s. Individuals and businesses didn’t spend their money—they held on to it because prices kept getting lower. The effects were harsh. Reluctance to spend and invest resulted in an economy that didn’t grow for almost 20 years. Fortunately, deflation is rare in the United States. There hasn’t been an extended deflationary period since the Great Depression in the 1930s.

For an in-depth look at the impact of inflation and deflation on an economy, check out this video lesson from Khan Academy titled “Winners and Losers From Inflation and Deflation.” Links to an external site.