Under deflation, or a sustained decline in prices, a decline in prices of goods and services leads to a decrease in firms’ sales and profits, which in turn results in wage restraint. Consequently, the economy falls into a vicious cycle where sluggish consumption leads to a further decline in prices.
On the other hand, the opposite cycle would arise if prices rise in a stable manner, and firms and households start to behave based on this assumption. If firms’ sales and profits increase due to rises in prices of goods and services, wages would increase accordingly, leading to more active consumption.