What is deflation?

Deflation is a sustained decline in the overall price level. It sounds good for buyers, but it matters because it can discourage spending and make debts heavier, which can slow an economy further.

How it works

If people expect prices to fall, they delay purchases because waiting is cheaper. Lower spending reduces sales, so firms cut prices and wages, and the expectation of falling prices is confirmed. This is a reinforcing loop that can feed on itself.

Debt makes it worse. A loan is fixed in money terms, but if wages and prices fall, the same payment takes a larger share of income. Borrowers cut other spending or default, which reduces demand further. Central banks therefore usually aim for a small positive rate of inflation rather than zero, to leave room against this spiral.

Example

Say a household owes 10,000, earns 2,000 a month and pays 500 a month on the loan, a quarter of its income. If wages fall 10 percent, income becomes 1,800 and the same 500 is about 28 percent of income. With a further 10 percent fall, income is 1,620 and the payment is about 31 percent. The household cuts spending on other things to keep paying, and that reduces other people's income. The figures are an illustration.

How to model it in Machinations

Create a Pool for household income and a Drain for the fixed loan payment. Add a Register for the price level that falls each step, and a Register for expected prices that lowers spending through a state connection. Spending feeds a Pool of firm revenue, which sets next step's wages. Play with a price decline Lever at 0 and at 5 percent per step and chart spending and the payment share.