If a central bank decides to impose a tighter monetary policy and the government starts to sell off some of its securities, it could reduce the supply of money in the economy, causing a disinflationary effect. Similarly, a contraction in the business cycle or a recession can also trigger disinflation.
Deflation can be caused by an increase in productivity, a decrease in overall demand, or a decrease in the volume of credit in the economy. Most of the time, deflation is unambiguously a positive trend for the economy, but it can also, under certain conditions, occur along with a contraction in the economy.
Deflation looms in the UK, and its potential impact on the economy is becoming a growing concern. Recent data shows that in December 2025, UK shop prices saw their sharpest decline in over 3 years, with annual shop price deflation reaching 1%, up from 0.6% in November.
Disinflation refers to a slowdown or a fall in the annual rate of price inflation. Consumer prices are still increasing, but more slowly. This drop in the inflation rate may be temporary in nature.
Inflation is better than deflation. Deflation completely ruins the economy, whereas moderate levels of inflation helps in the growth of the economy, it leads to more investments, production and employment.
When inflation is running above a central bank's target, policymakers may tighten monetary policy to bring inflation back down, in essence, to generate disinflation.
Disinflation is caused by several different factors. A recession or a contraction in the business cycle may result in disinflation. It may also be caused by the tightening of monetary policy by a central bank. When this happens, the government may also begin to sell some of its securities and reduce its money supply.
After the inflation of the First World War, the UK experienced deflation (falling prices) during the 1920s and early part of 1930s. This deflation was due to tight monetary and fiscal policy and an overvalued exchange rate (Gold Standard).
The Sunday Telegraph carries warnings from leading economists that Britain is heading towards a 1970s-style debt crisis, and a bailout from the International Monetary Fund (IMF).
Many people have some sort of debt, eg a mortgage, a student loan or a credit card. Deflation can make it more expensive to repay your debts because, regardless of the general prices for goods and services, the amount of money you owe remains the same.
A recession-resilient portfolio might include a larger share of bonds, dividend-paying stocks, and cash equivalents like Treasury bills or money market funds. These can offer lower returns, but they also help limit downside risk and give you liquidity if opportunities arise.
To calculate the GDP price deflator, divide the nominal GDP by the real GDP and multiply the result by 100. Nominal GDP is the total value of goods and services produced during a specific period less the value of products made during production.
Central Bank Response: Central banks often use monetary policy tools to manage disinflation. They may raise interest rates to reduce demand and prevent prices from rising too quickly. Conversely, central banks may lower interest rates to stimulate demand and prevent prices from falling too rapidly.
A liquidity trap may be defined as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the economy has no effect, because [monetary] base and bonds are viewed by the private sector as perfect substitutes.
Creeping inflation is a type of inflation that occurs slowly and gradually. It is characterized by a steady increase in prices over time, without any sudden or dramatic changes. Creeping inflation can be difficult to detect, as it can be masked by other factors, such as economic growth.
Certain fiscal and monetary policies can contribute to deflation. For instance, a government reducing public spending or a central bank increasing interest rates can slow economic activity and put downward pressure on prices.
Here are some real-world examples of disinflation and deflation: Disinflation in the United States. The United States experienced disinflation in the early 1980s. The inflation rate peaked at 14.8% in 1980 and then fell to 3.2% in 1983.
Phillips's “curve” represented the average relationship between unemployment and wage behavior over the business cycle. It showed the rate of wage inflation that would result if a particular level of unemployment persisted for some time. Economists soon estimated Phillips curves for most developed economies.
Is deflation worse than inflation? Deflation is often tougher to combat than inflation, because the Federal Reserve's biggest lever — interest rates — is limited. In a deflationary environment, the Fed wants to get people to spend more money, so it makes access to credit cheaper.
The low inflation in China reflects a disinflation process, primarily driven by a stronger recovery on the supply side than on the demand side, coupled with intense competition in consumer products.
