Like they were five years ago, economists again are talking about the dangers of deflation. A reader asks:

Could you explain what is bad about deflation? I understand why inflation is bad, and I presume that deflation is the opposite of inflation. If so, why is it bad if my money is increasing in value rather than decreasing?

The short answer is that deflation, like inflation, can kill demand and productive economic growth. First, inflation. Inflation is a persistent and broad increase in prices. It does damage two ways. 1) It drives up interest rates, which makes it more expensive to borrow, which hurts consumer and business demand. (High inflation causes lenders to demand high interest to compensate.) 2) Long-term, severe inflation distorts the price signals that are essential for efficient economies.

Deflation is a persistent and broad decrease in prices. Deflation arrives when there is too much productive capacity/supply and too little demand. (The real estate market, with 11 months' supply of empty homes trying to get sold, is the primo example.) When supply is too great relative to demand, companies cut prices. Lower prices mean lower profits, and lower profits cause debt defaults and layoffs, which reduces demand even more. Perhaps the most damaging deflationary outcome is when consumers stop spending because they see prices falling and figure the car they want will be cheaper in six months. So they wait. Then they may wait another six months, especially if they just got laid off. This puts new pressure on companies.

There is no macro deflation yet in the U.S. economy. True, car and house prices are falling. But it's not deflation until there is a broad and persistent fall in the overall consumer price index. Yesterday's interest-rate cut by the Federal Reserve was intended to flood the economy with money, spur borrowing and demand and forestall deflation. Eventually it will work.