Definition and Example of Deflation
Deflation is an economic term that describes an environment of declining prices for goods and services within an economy. Not to be confused with disinflation (a decrease in the rate of inflation), deflation can also be called negative inflation because it occurs when inflation is less than 0%.
Deflation can occur in recessions, where the demand for most goods and services declines and the providers of these goods and services lower prices to compete for fewer consumer dollars. In extreme cases, consumers delay purchases in anticipation of further price declines. This can often lead to a self-fulfilling prophecy of lower prices.
A recent example of deflation occurred during "The Great Recession" of 2007-2008, where the inflation rate fell below 0%. An extreme example of deflation occurred during The Great Depression.
Deflation Investment and Hedge Strategies
During deflation, asset prices are falling so you'll generally want to avoid assets such as cash, gold, real estate and stocks. This is the opposite of inflation where these assets can be good bets. Good investments during deflation may include bond funds, especially long-term bonds because interest rates are falling (and bond prices may therefore be increasing), and certain sector funds that invest in defensive areas, such as health care and utilities--things people need regardless of economic conditions.
Tip and Caution
Trying to navigate market and economic conditions with investment strategies is a form of market timing that carries significant risk of losing value in an investment account. For most investors, building a diversified portfolio of mutual funds is the best strategy for all market and economic environments.
See Also: Inflation, Hyperinflation, Stagflation, and Reflation.
Disclaimer:
The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
