What is the term for a reduction in the general level of prices over time? The answer is deflation.
Deflation is a sustained decrease in the broad price level of goods and services, meaning the inflation rate becomes negative. Because each unit of currency can buy more than before, deflation increases money’s real purchasing power. It is measured through broad price indexes rather than by a single product becoming cheaper.
Deflation can result from weak aggregate demand, a contraction in the money or credit supply, or productivity gains that reduce costs across many industries. It is not automatically beneficial: falling prices can reduce business revenue, wages, production, and employment. Unexpected deflation also raises the real burden of debts whose nominal amounts remain fixed.
A common mix-up is deflation versus disinflation. Disinflation means inflation is slowing but remains positive—for example, prices rising 2% instead of 6%. Deflation means the overall price index is actually falling. A deflationary spiral can occur when falling prices weaken production and incomes, which then depresses demand further. The Great Depression is often discussed in connection with severe deflation.