Glossary

Deflation is a decrease in the general price level as measured by a broad-based price index. Deflation is often the result of an overvalued currency that raises the cost of labour in relative terms. If, at the same time, the cost of capital is also high —due, for example, to weak and malfunctioning political institutions— the ensuing decline in corporate profits leads to low investment and high unemployment. In such a scenario, deflation wreaks havoc on the economy, as slow economic growth dents tax revenue, leading to a fiscal crisis and debt defaults. Deflation needs to be distinguished from disinflation, which is a decline in the (positive) rate of inflation over time.