Deflation, often seen as the opposite of inflation, can be just as destructive to the economy. While inflation erodes the value of money and destroys risk assets, deflation can have a devastating impact on economic activity, credit markets, and employment. Here's why:

Deflation, unlike inflation, does not directly affect the consumer's purchasing power. However, it can be a major spending deterrent. When prices fall, the value of the currency increases, making holding cash a lucrative investment. This leads to delayed spending, which can slow down economic growth. In an economy heavily reliant on consumer spending, this can have significant consequences.

Deflation also crushes credit markets. Unlike inflation, where debt is inflated away, deflation makes debt more expensive. This increases the likelihood of defaults and makes borrowing more difficult. As a result, debtors are burdened by higher servicing costs, and borrowers are deterred from seeking loans, leading to a growth implosion.

Deflation also takes a toll on wages and employment. As the value of the currency increases, nominal pay should decline to reflect the deflation. However, employers tend not to lower wages; instead, they fire workers to reduce costs. This phenomenon is known as downward nominal wage rigidity. Employers are reluctant to reduce nominal wages, fearing that it may lead to higher-value workers quitting. Therefore, they opt for layoffs to reduce expenses.

In summary, deflation can be just as destructive as inflation. It makes holding cash a lucrative investment, crushes credit markets, and hurts wages and employment. Both inflation and deflation are sides of the same economic coin, each with its own set of unpleasant consequences.