What is deflation? It’s not a one-time price discount — and it’s not something to cheer, economists say.

Start with one remark from Walmart
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-0.60%
CEO Doug McMillon during the company’s Thursday quarterly earnings call.

“In the U.S., we may be managing through a period of deflation in the months to come, and while that would put more unit pressure on us, we welcome it, because it’s better for our customers,” McMillon told analysts, according to a FactSet transcript.

General-merchandise prices are coming down just in time for the holidays, and there are lower prices for dairy, eggs, chicken and seafood, he said.

It’s too soon to say how pronounced any deflation would be, he noted. Walmart shares closed at $156.04 on Thursday, down 8%. The S&P 500
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and Nasdaq Composite
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closed barely higher, while the Dow Jones Industrial Average
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ended slightly down.

One day earlier, Cathie Wood, chief executive at Ark Invest, said “deflation is the greater risk here,” compared with the chance of more inflation.

Here’s a side dish to Wood’s comments: The Thanksgiving meal that millions of Americans will eat next week is projected to be cheaper than it was a year ago.

The average $61.17 cost for turkey and all the trimmings to feed 10 people will be 4.5% less than the record-breaking $64.50 last year, according to the American Farm Bureau Federation.

So why are economists saying any large-scale price reductions would be a source of worry instead of something to cheer?

For one thing, it’s happening amid the ongoing debate over whether the economy is slowing into a recession.

“In theory, deflation basically says that the economy might be in trouble because it’s very weak,” said Eugenio Alemán, chief economist at Raymond James.

Businesses “need to move their inventory, and the only way you can move inventory in such an environment, if the economy is weak, is to lower price,” he said.

The overall cost of living didn’t change from September to October, and the year-over-year inflation rate eased to 3.2% from 3.7%, according to the Bureau of Labor Statistics.

But there are those who doubt the chance of deflation happening.

On one hand, Alemán thinks the economy could be inching a little closer to a deflationary environment. But Michael Pearce, lead U.S. economist at Oxford Economics, isn’t buying the idea. The chances of deflation are “pretty thin,” he said, adding, “The problem right now is still stamping out inflation.”

What is deflation, anyway?

Inflation is the general rise in the price of goods and services across the economy. The Federal Reserve tries to keep inflation at an annual rate of 2%. When inflation heats up, consumers feel the pinch of higher prices, as they learned all too well starting in 2022.

Then there’s deflation. “A period of deflation would suggest that most prices across the economy are falling outright,” Pearce said.

There’s also disinflation, which occurs when the inflation rate is still moving higher, but more slowly. It’s possible that pockets of deflating prices can contribute to disinflation, Alemán noted.

But pockets of decreasing prices don’t equate to deflation, said Preston Caldwell, Morningstar’s chief U.S. economist. He doesn’t think any type of large-scale deflation is approaching, saying: “Are we seeing deflation in certain categories helping aid the return to normal for overall inflation? Yes.”

How would deflation affect consumers?

If prices generally decrease, that might help people on a fixed income, Pearce said. High inflation erodes purchasing power, which is why inflation adjustments for Social Security recipients are such a big deal. Savers would also see their cash go a little further, he noted.

“The problem is deflation implies much slower growth in incomes as well., Pearce added. That’s because businesses that are lowering prices in response to lower demand will not be raising wages by much. And while it might be unpalatable to cut worker wages in the face of deflation, he noted, businesses can cut jobs.

After all of the focus on raising interest rates to combat inflation, deflation would cast a different light on rates, as the debt payments on fixed-rate loans — like a mortgage or a car loan — would become more onerous, economists told MarketWatch.

With a fixed-rate loan, the borrowing cost is set and the principal captures the value of an asset at one point in time. So if wages go up with inflation, the borrower could have more spending power to pay the loan.

But deflation means that the set debt amount saps a larger part of the borrower’s spending power, Alemán noted. “In the same way that inflation is good for fixed-rate loans because over time you pay less, deflation is bad for fixed rates because you pay more in real terms,” he said.

This helps explain why farmers were in such a bad way during the Great Depression nearly a century ago, which Caldwell at Morningstar said was the last time the economy endured outright deflation. While crop prices cratered, the real value of farmers’ mortgage debt increased, he said.

“Deflation is a major problem in any economy like ours, where most debt contracts are not indexed to inflation and are fixed in nominal terms,” Caldwell said.

Why worry about deflation?

Household debt is already large, and it’s still growing. Through the third quarter of 2023, Americans had more than $1 trillion in credit-card debt. But with slower wage growth and more money going to debt in real terms, it eventually becomes harder to pay off amassed debts, Pearce said.

The same economic rules would apply to businesses and to government, he added. Their debts become more burdensome and soak up spending that would otherwise fund jobs and projects.

“The poster child for deflation is Japan,” Pearce said. The country faced a “lost decade” that started in 1991, during which deflation was one of the economic conditions contributing to recession.

There might come a time in the next five to 10 years when the chance of deflation could increase, Pearce said, but added: “Right now, there’s nothing to worry about. The problem is still too-high inflation.”