An economic downward spiral that is fueled by economic agents on the demand side putting a hold on purchase decisions in expectation of lower prices, leading to an overall tendency to sell and postpone purchases to the future, driving prices down even in a faster pace, leading to more deflationary pressures and additional rounds of selling until most economic agents have no assets other than cash. In its extreme scenario, a deflationary spiral bogey may be a theoretical setting.

In its ordinary form, a deflationary spiral bogey is a situation in which an economy enters a stage of deflation that once in full swing feeds on itself, reducing overall economic activity and paralyzing the economy at large. Deflation, by definition, is a fall in the general price level or a contraction of credit and broadly the supply of money in an economy. The deflationary spiral is associated with falling prices, where consumers tend to delay spending and consumption on expectation of further price drops, and so on. In turn, the productive capacity becomes under-utilized and investment falls, leading to further contraction in aggregate demand.

Deflation discourages spending, and negatively impacts investment, because consumers, expecting prices to fall yet further, hold on spending decisions, opting instead to build up savings and wait for even further price falls. Consequently, decreased spending substantially impacts corporate sales and profits, eventually enticing layoffs and contributing to wide-spread unemployment across various economic sectors.

Deflationary spiral bogey is the macroeconomic equivalent of the proverbial “roach motel“: a place (or a situation) that is easy to enter, but is either difficult to leave or extracts a high cost/ penalty while attempting to exit.

In a nutshell, deflation hinders consumption, which negatively impacts production, and eventually paralyzes all economic activity.