LeoGlossary: Deflation

The contract of the money supply, especially currency.

When people pay off their debt or default on loans, money is destroyed. This is the opposite of inflation which is the expansion through the creation of loans by commercial banks.

Loan payments contain two parts:

• principal
• interest

Each repayment, the portion that goes toward principal (reducing the balance), contracts the money supply.

With defaults, the reduction takes place when the lender is forced to write the loan off. Then it is erased from its ledger.

Cryptocurrency operates a bit different.

The most obvious form of deflation is when tokens or coins are burned. This takes the circulating supply down.

Another way, although difficult to quantify, is when people lose their keys. While this is still in the circulating supply, the coins or tokens are effectively lost.

The result of deflation could be an increase in purchasing power. Prices move for many different reasons and monetary factors are only one variable. It is possible for the money supply to be contracting yet purchasing power is still being lost. Supply and demand issues are always a major factor in how markets price things.

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