The dynamics of deflation in a growing economy

Abstract

In this paper I study the behavior of prices in a growing economy in which the money supply is held constant. I show that with increasing levels of output, it is a natural outcome that prices of economic goods will decrease over time, which it is what we define as deflation. In this context, I study in particular the behavior of real and nominal incomes (wages and profits) over time, the evolution of nominal and real GDP and the effects of deflation on debt contracts. Specifically, I assess the common claims that deflation decreases incomes, postpone spending and favors creditors at the expense of debtors. I have found that none of these claims is supported by theoretical analysis in the case that price deflation is the consequence of economic growth with constant money supply.