Among the many macroeconomic indicators that can have an impact on the nation's economy, deflation is a primary one. It is one of those economic variables that the economists fear the most. The article encapsulates the trends of deflation in the global context that includes countries like Japan, China, Taiwan and Europe. It then moves on to discuss how deflation can be transmitted to other nations and how it can pose a challenge to the central banks of the countries.

After decades of fighting the inflation syndrome, the primary concern of policymakers and economists has turned towards warding off deflation. The recent discussions of policy makers, economists and central bankers revolve around the possibility of global deflation; a situation of persistent fall in prices.

The major threats of deflation to an economy and its growth are not unknown. It has severe adverse effects on an economy more so when the interest rates touch rock bottom. Banks are the major losers in a deflationary scenario. The losses come from the decline in the real value of assets forfeited to banks by borrowers as collateral security. As the prices decline and the value of assets fall the borrowers tend to default on their loans. As the number of defaulting borrowers increase the NPAs soar up resulting in huge losses for banks. Losses are compounded by the falling interest rates and this leads to bank failures. "Debt-deflation" is the term coined by Irving Fisher for this phenomenon. A debt-deflation is generally preceded by a boom accommodated by a big run-up in debt, as it happened in Japan. Deflation in Japan was an aftermath of a boom in the real estate industry that involved huge investments based on over optimistic expectations about a huge rise in future profits and sales. When the expectations do not turn true the immediate upshot is the bankruptcies of the over-leveraged and over-invested individuals and firms. Real estate investors in Japan went bankrupt, which laid the foundation for the banks that had lent them to default. This resulted in a deflationary spiral.

The strongly held expectations of a further fall in prices amplify deflationary pressures. The drastic fall in prices might bring relief to a common man and in the hope of a further fall in prices he tends to postpone his spending. This widens the output gap (a gap between aggregate demand and output) and a vicious cycle is created. The widening output gap renders a drop in the manufacturing activities, which results in a further fall in the prices. This ongoing phenomenon leads to a deflationary spiral.

Deflation, macroeconomic indicators, economic variable, inflation syndrome, policymakers, economists, central bankers, global deflation, economy, growth, interest rates, major losers, real value of assets, collateral security, defaulting borrowers, NPAs, Debt-deflation, Irving Fisher, Japan, real estate industry, bankruptcies, over-invested, deflationary spiral.