For example, deflation can be particularly harmful when the financial system is already fragile, with household and corporate balance sheets in poor condition and with banks undercapitalized and heavily burdened with nonperforming loans. Under such circumstances, deflation or unexpectedly low inflation, by increasing the real burden of debts, may exacerbate financial distress and cause further deterioration in the functioning of the financial markets.
This process of “debt deflation” (a term coined by the early twentieth-century American economist Irving Fisher) was important in the U.S. deflation and depression of the 1930s and may have played an important role in the economic problems of contemporary Japan.