Friday, July 17, 2009

What is deflation?

It's the opposition of inflation. When prices fall you have deflation. Most governments don't want to see prices fall. If people believe it will cost less to buy something in a month, they'll put off that purchase. If enough people do that, then prices will come down. That can pick up momentum to the point that there's a downward spiral in prices, companies stop producing products as demand falls and people lose their jobs.

But deflation is not always a bad thing. If falling prices are caused by faster productivity growth, as in the Industrial Revolution of the late 19th century, then it can go hand in hand with strong growth. However, if deflation reflects excess capacity and a slump in demand, it can be dangerous, as it was in the Great Depression of the 1930s. Prices tumbled and millions of jobs disappeared.

While Canada technically experienced deflation in June 2009, economists don't expect it to be a trend - or anything to worry about. Again, if you take out the effect of falling gasoline prices, the rest of the basket of goods and services Statistics Canada measures came in 2.1 per cent higher than in June 2008. Gasoline prices hit record highs of more than $1.30 a litre in the summer of 2008 before declining to around 76.5 cents a litre in December. So lower gasoline prices could lead to a few months of "deflation" in 2009.

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