Inflation-Deflation Spiral

What this diagram shows

The inflation-deflation spiral diagram illustrates how an economy can get trapped in a self-reinforcing cycle of falling prices, reduced spending, and economic decline. It shows how initial deflation leads to consumers delaying purchases (expecting lower prices tomorrow), which reduces demand, forces businesses to cut prices further, and creates unemployment. This creates a vicious cycle where each stage reinforces the others, making it extremely difficult for the economy to recover without significant government intervention.

Key points

• Deflation creates expectations of further price falls, encouraging consumers to delay spending
• Reduced consumer spending leads to falling aggregate demand and business revenues
• Businesses respond by cutting production, employment, and prices to try to stimulate demand
• Rising unemployment reduces disposable income, further decreasing consumer spending
• The cycle becomes self-perpetuating as deflationary expectations become entrenched in the economy

Exam board notes

All major exam boards treat this diagram identically, though OCR tends to link it more explicitly to liquidity traps and monetary policy limitations. AQA often combines it with Phillips Curve analysis in longer essay questions.