What is the self-reinforcing cycle where falling prices reduce spending, output falls, unemployment rises, and further price falls?

• A. Deflationary spiral
• B. Deflation
• C. Inflation
• D. Stagflation

Answer: (A)

Deflationary spiral is a self-reinforcing downward cycle of prices and activity. When prices start to fall, people cut back on spending because they expect prices to drop further or their purchasing power feels tighter. Firms respond by reducing output, which raises unemployment. With more people out of work and incomes squeezed, overall demand weakens even more, putting additional downward pressure on prices. The cycle feeds on itself and can be hard to stop without external stimulus. This differs from deflation, which is simply a general fall in the price level; the spiral specifically describes the continuing feedback loop that deepens an economic slump.