In most countries, including the United States, general prices are measured in terms of consumer price indices, which are the weighted averages of baskets of goods and services purchased by consumers. Put very simply, deflation can be understood as a continuous decline in consumer prices. What happens to the economy if prices as a whole decline continuously (Chart 1)?
Looking at the overall economy, suppliers of goods and services will see a decrease in sales and profits, and firms with declining profits typically start to lay off employees or restrain their wages. Employees that have been laid off or whose wages have declined experience a fall in their income and restrain their spending due to uncertainty about their future.