Then there is the more familiar deflation situation where there is significant deleveraging after the bust of a credit boom. Even with attempts to boost money supply via easy credit, it could not make up for the fall of credit due to deleveraging and leads to deflation. Here the debt overhang of the credit boom becomes a greater burden as price level decreases which in turn leads to lower economic growth. This is what took place in Japan starting in the mid 1990s and there is a risk of this in Europe today. USA seems to have avoided this situation although it did have some deflation in 2009.
This indicates that deflation is a consequence of economic stagnation rather than a cause. Given that people inherently prefer present items to future items, mild deflation is not going to be a cause of economic stagnation. All things being equal, deflation will encourage saving over spending which increases the supply of money available for production. Mild inflation may be useful for increasing short-term spending but is counterproductive toward encouraging long-term investment.
