Why deflation is bad

NYT columnist Paul Krugman offers a little primer:

When people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield - Japanese bank deposits are a really good deal compared with those in America -- and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed.

The more prices fall, the more likely people will assume they'll keep falling and pretty soon the cycle becomes hard to stop. Calculated Risk adds an important point about wages.

With some inflation, real wages can be cut (if needed) by keeping wage increases below the inflation rate. However, if inflation is near zero - or there is deflation - many companies that need to cut wages a little will have difficulty competing since it is difficult to cut nominal wages. This is a key reason why a little inflation is better than no inflation. Of course too much inflation is really bad too, but that isn't the problem right now.

In an earlier post, Krugman warns about accepting a persistently depressed economy as being normal:

Picture America in, oh, 2014: unemployment is still around 9 percent, prices are falling about 1 percent a year. Many economists might look at that situation and say, well, deflation is stable, not accelerating, so we must be at the natural rate of unemployment -- move along, folks, nothing to see here.