Dion writes:

What's the difference between deflation and a depression? Is this just wordsmithing so everyone doesn't freak more than usual or is there a genuine factual or concrete economic difference?

Dion, you're so in luck. Economist Amir Sufi rings in today with an answer. It's after the jump.

Amir Sufi writes:

There is an important difference between "depression" and "deflation."
"Deflation" is a term that refers to a situation when there is a sustained drop in prices in the economy. Policy-makers are very concerned about a possible deflationary cycle -- when prices start to drop, consumers may believe that prices will drop further. As a result, they delay consumption (i.e., buying stuff), which makes the drop in prices inevitable. A sharp drop in prices also leads to businesses cutting back on investment, production, and employment because they cannot sell goods at profitable prices. This can further exacerbate the downturn in the economy. The Great Depression was characterized by a deflationary cycle, which many believe was partially responsible for the depths of the economic downturn.
In contrast, a "depression" is a word for a prolonged and very deep recession, which is a reduction in the total output of the economy. Precisely when a recession becomes a depression is not well defined.
So in summary, deflation refers to a drop in prices, whereas a depression represents a very severe and prolonged reduction in total economic output (i.e., all the goods bought and investment undertaken in the whole economy).

categories: Questions from You

11:03 - November 26, 2008

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