What it is
Deflation occurs when the overall cost of living falls over time, meaning consumers can buy more with the same amount of money. It is typically measured by a negative annual percentage change in a broad price index, such as the Consumer Price Index (CPI) or the Personal Consumption Expenditures (PCE) index. While lower prices might seem beneficial, prolonged deflation can signal a weakening economy, as consumers may delay purchases anticipating even lower prices, reducing demand and economic activity.
Central banks, like the Federal Reserve, generally view deflation as a significant economic threat because it can lead to a downward spiral of declining demand, production, and wages. Policymakers combat deflation primarily through monetary policy tools such as lowering interest rates, including the federal funds rate, or implementing quantitative easing to stimulate spending and investment. Deflationary pressures can be seen in reports like the CPI, and economists watch for it as a sign of potential recession.
Why it matters
Deflation erodes corporate profits and can signal a recession, impacting investments. It also increases the real burden of debt, affecting borrowers and the broader economy.
Reviewed under editorial standardsUpdated September 26, 2026Not investment advice