Deflation is both a sign of economic weakness and a real danger. In a weak, no growth economy there is no pressure on prices, little demand for most goods or services and flat to falling wages as unemployment rises. Falling prices signal spreading economic malaise.
Deflation can be a greater danger – when prices fall, just about everything except for cash is worth less; cash is worth more because each dollar buys more. In effect, dollars are more expensive. A borrower needing money to repay a loan must work longer and harder to repay the loan because his labor is worth less. This debt-deflation spiral can send an economy into a deep recession or worse. This is why the ECB and others fear deflation.
This article was written by David Blitzer, chairman of the index committee, S&P Dow Jones Indices.
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