What is deflation? It’s not a one-time price discount — and it’s not something to cheer, economists say

Start with one remark from Walmart
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+0.69%
CEO Doug McMillon during a Thursday quarterly earnings call.

“In the U.S., we may be managing through a period of deflation in the months to come and while that would put more unit pressure on us, we welcome it, because it’s better for our customers,” McMillon told analysts, according to a FactSet transcript.

General merchandise prices are coming down just in time for the holidays, and there are lower prices for dairy, eggs, chicken and seafood, he said.

It’s too soon to say how pronounced any deflation would be, he noted. Walmart shares closed at $156.04 on Thursday, down 8%. The S&P 500
SPX
and Nasdaq Composite
COMP
closed barely higher while the Dow Jones Industrial Average
DJIA
ended slightly down.

One day earlier Cathie Wood, chief executive at Ark Invest, said “deflation is the greater risk here,” compared with the chance of more inflation.

Here’s a side dish to Wood’s comments. The Thanksgiving meal that millions of Americans will eat next week is projected to be cheaper than a year ago.

The average $61.17 for turkey and all the trimmings to feed 10 people will cost 4.5% less than the record-breaking $64.50 one year earlier, according to the American Farm Bureau Federation.

So why are economists saying any large-scale price reductions would be a source of worry instead of something to cheer?

For one thing, it’s happening amid the ongoing debate over whether the economy is slowing into a recession.

“In theory, deflation basically says that the economy might be in trouble because it’s very weak,” said Eugenio Alemán , chief economist at Raymond James.

Businesses “need to move their inventory and the only way you can move inventory in such an environment, if the economy is weak, is to lower price.”

The overall cost of living didn’t change from September to October and the year-over-year inflation rate eased to 3.2% from 3.7%, according to the Bureau of Labor Statistics.

But there are those who doubt the chance of deflation happening.

On one hand, Alemán thinks the economy could be inching a little closer. But Michael Pearce, lead U.S. economist at Oxford Economics, isn’t buying the idea. The chances of deflation are “pretty thin,” he said, adding, “The problem right now is still stamping out inflation.”

What is deflation anyway?

Inflation is the general rise in the price of goods and services across the economy. The Federal Reserve tries to keep inflation at an annual rate of 2%. When inflation heats up, consumers feel the pinch of higher prices, as they learned all too well starting in 2022.

Then there’s deflation. “A period of deflation would suggest that most prices across the economy are falling outright,” Pearce said.

There’s also disinflation. Not to be confused with deflation, disinflation occurs when the inflation rate is still moving higher, but at a lesser degree. It’s possible that pockets of deflating prices can contribute to disinflation, Alemán noted.

Pockets of decreasing prices don’t equate to deflation, said Preston Caldwell, Morningstar’s chief U.S. economist. He doesn’t think any type of large-scale deflation is approaching. “Are we seeing deflation in certain categories helping aid the return to normal for overall inflation? Yes.”

How would deflation affect consumers?

If prices generally decrease, that might help people on a fixed income, said Pearce. High inflation erodes purchasing power, which is why inflation adjustments for Social Security recipients are such a big deal. Savers would also see their cash go a little further too, he noted.

“The problem is deflation implies much slower growth in incomes as well.” Pearce added. That’s because businesses lowering prices amid lower demand will not be adding much to wages. It might be unpalatable to cut worker wages in the face of deflation, but businesses can cut jobs, Pearce added.

After all the focus on high interest rates to combat inflation, deflation would cast a different light on rates. The debt payments on fixed-rate loans — like a mortgage or a car loan — would become more onerous, economists told MarketWatch.

In a fixed-rate loan, the borrowing cost is set and the principal captures the value of an asset at one point in time. So if wages go up with inflation, there could be more spending power to pay on the loan.

But deflation makes the set debt amount sap a larger part of the spending power, Alemán noted. “In the same way that inflation is good for fixed-rate loans because over time you pay less, deflation is bad for fixed rates because you pay more in real terms,” he said.

This helps explain why farmers were in such a bad way during the Great Depression nearly a century ago, which Caldwell at Morningstar said was the last time the economy endured outright deflation. While crop prices cratered, the real value of their mortgage debt increased, he said.

“Deflation is a major problem in any economy like ours, where most debt contracts are not indexed to inflation, and are fixed in nominal terms,” Caldwell said.

Why worry about deflation?

Household debt is already large and growing. Americans now have more than $1 trillion in credit-card debt through the third quarter. But with slower wage growth and more money going to debt in real terms, it eventually becomes harder to pay off amassed debts, Pearce said.

The same economic rules would apply to businesses and to government, he added. Their debts become more burdensome and soak up spending that would otherwise fund jobs and projects.

“The poster child for deflation is Japan,” Pearce said. The country faced a “lost decade” that started in 1991 where deflation was part of the economic brew contributing to recession.

There might come a time in the next five to 10 years when the chance of deflation could increase, Pearce said. “Right now, there’s nothing to worry about. The problem is still too-high inflation.”