Introduction
Deflation refers to a sustained decline in the general price level of goods and services in an economy. It is distinct from disinflation, which is a slowdown in the rate of inflation. Deflation can be triggered by both demand-side and supply-side factors. On the demand side, a sharp contraction in aggregate demand due to factors like recession, financial crisis, or a decline in consumer confidence can lead to deflation. On the supply side, deflation can be caused by technological advancements, increased productivity, or a significant reduction in production costs. While deflation might appear initially beneficial due to lower prices, it often leads to a spiral of negative consequences for the economy.

Positive Consequences of Deflation (Short-lived and Limited)
Acknowledging the potential benefits, falling prices can lead to increased purchasing power for consumers, as their money can buy more goods and services. This can stimulate consumer spending in the short term. Additionally, deflation can improve a country's international competitiveness, as its exports become relatively cheaper. However, these benefits are often short-lived and can be outweighed by the negative consequences if deflation persists.

Negative Consequences of Deflation
1. Deferred Consumption and Investment
Deflation creates an environment of uncertainty and discourages spending. Consumers tend to delay purchases, expecting further price drops in the future. This phenomenon is known as "deferred consumption." Similarly, businesses postpone investments due to weak demand and uncertainty about the future profitability of their ventures. This decline in both consumer and business spending leads to a significant contraction in aggregate demand, further deepening the deflationary cycle.

2. The Debt Deflation Spiral
Deflation poses a significant threat to borrowers by increasing the real value of their debt. As prices fall, the value of money rises, making it more difficult for individuals and businesses to repay their existing loans. This can lead to a cascade of defaults, impacting financial institutions and their ability to extend credit. As credit markets tighten, businesses find it harder to access funding, further hindering investment and economic activity, perpetuating the "debt deflation spiral" (Fisher, 1933). This phenomenon was a key factor in the severity of the Great Depression.

3. Wage and Price Rigidity
Wages and prices exhibit "downward stickiness," meaning they are slow to adjust downwards, especially in the face of deflation. This stickiness stems from factors like labor contracts, minimum wage laws, and social norms. As deflation sets in, firms find it challenging to reduce wages, even in the face of declining revenues. This reluctance leads to job losses as companies resort to layoffs instead of wage cuts, further reducing aggregate demand. Similarly, businesses are often hesitant to lower prices, fearing a price war and damaging their brand image. This price stickiness hinders the deflationary adjustment process and exacerbates the economic downturn.

Conclusion
The consequences of deflation for an economy are generally negative and can be severe. It leads to a vicious cycle of falling prices, reduced demand, and economic stagnation. To combat deflation, policymakers can implement a combination of monetary and fiscal policies. Monetary policy measures like quantitative easing can increase the money supply, stimulate lending, and lower interest rates. Fiscal policy measures like government spending on infrastructure and social programs can directly boost aggregate demand. These measures should be coordinated and implemented proactively to prevent deflation from spiraling into a prolonged economic slump.

Sources:

Fisher, I. (1933). The debt-deflation theory of great depressions. <i>Econometrica</i>, <i>1</i>(4), 337-357.