A situation in which an economy enters a stage of deflation that once in full swing feeds on itself, reducing overall economic activity and paralyzing the economy at large. Deflation, by definition, is a fall in the general price level or a contraction of credit and broadly the supply of money in an economy. The deflationary spiral is associated with falling prices, where consumers tend to delay spending and consumption on expectation of further price drops, and so on. In turn, the productive capacity becomes under-utilized and investment falls, leading to further contraction in aggregate demand.
Deflation discourages spending, and negatively impacts investment, because consumers, expecting prices to fall yet further, hold on spending decisions, opting instead to build up savings and wait for even further price falls. Consequently, decreased spending substantially impacts corporate sales and profits, eventually enticing layoffs and contributing to wide-spread unemployment across various economic sectors.
Deflationary death spiral is the macroeconomic equivalent of the proverbial “roach motel“: a place (or a situation) that is easy to enter, but is either difficult to leave or extracts a high cost/ penalty while attempting to exit.
In a nutshell, deflation hinders consumption, which negatively impacts production, and eventually paralyzes all economic activity.
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