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Deflation is a general decrease in the price of goods and services in an economy over time. This results in higher purchasing power for the relevant currency. Deflation is rare in modern economies, occurring most often during recessions. Short-term deflation can have varying effects on the economy. Long-term deflation is generally bad for an economy. Deflation is the opposite of inflation.

Deflation is generally measured based on the prices of goods and services. These products’ prices are tracked by a weighted average market basket of many items, known as the consumer price index (CPI).

There are several possible drivers of deflation. If the money supply decreases, then the value of a currency will go up, which lowers prices. Alternatively, a sudden increase in the supply of goods and services will cause a lower equilibrium price, even though the value of the currency was unchanged.

A lower equilibrium price will also occur when the demand for goods and services goes down, as was the case in the early stages of the COVID-19 crisis. Regardless of the value of the currency, lower demand will force merchants to lower prices to stay competitive, resulting in deflation.

Learn more about the effects of deflation.