The Curious Economist | Deflation in Canada: why economists will tell you that falling prices is not something to be happy about

an image of Canadian dollars as the economy experiences deflation

The inflation rate in Canada entered negative territory in April, as year-on-year inflation was measured at -0.2%. This essentially means that the average price level in Canada was 0.2% less in April this year, than it was in 2019.

This decreasing rate of inflation, or fall in the average price level, is what economists call deflation. In the case of Canada, it has been the various demand and supply-side shocks caused by the spread of Covid-19 which has pushed down consumer prices.

Some of the major declines in price are shown below:

Now you may be thinking that with prices falling, this should be a cause for celebration, certainly not a cause for concern. Well, for a consumer at the checkout this may be the case, but as most economists will tell you, it definitely should not be celebrated.

And here is why.

Firstly, if prices are rising a little bit, that indicates a healthy economy. It demonstrates that demand for goods and services is high and the economy is growing. Now we don’t want high inflation as that will bring a host of other problems, this is why most economies around the world set themselves an annual inflation target of around 2%.

Secondly, deflation creates uncertainty. If prices are falling, consumers may hold back on making purchases in the hope that they’ll save even more by waiting a little while. This will have a negative impact on businesses revenue as demand for their goods and services begins to stagnate. With falling revenue, there could then be cost cutting measures leading to unemployment and a reduction in output. Both terrible outcomes for the health of the overall economy.

Another big problem with deflation is that it increases the debt burden. This means that those who have a lot of debt, are likely to experience a decrease in their income due to falling prices but the value of their debt will remain the same. This will put financial pressure on borrowers, leading to further shockwaves throughout the economy.

So there you have it Canada. Your groceries might be a bit cheaper this week but you better hope they won’t be for long. Deflation is a nightmare you don’t want to be trapped in!