Because nominal interest rates are bounded by zero, the potential for the central bank to reduce real interest rates to revive demand is constrained. A persistent decline in prices also encourages a delay in corporate spending on capital equipment, thus reducing the productive capacity of the economy. Thus, a period of deflation that does not reflect an increase in productivity growth is normally associated with a decline in economic output and in living standards. There is widespread agreement among economists that deflation, like inflation, is essentially a monetary phenomenon. Deflation is caused by a prolonged period of insufficient growth in the money supply that leads to insufficient growth in spending.
Deflation occurs when too little money chases too many goods for too long.
Since deflation is a monetary phenomenon, the normal antidote requires stimulative monetary policy. The central bank is obliged to cut interest rates and expand the money supply to boost spending. When the surplus of goods is depleted, prices stop falling. This practice has kept deflation at bay since the 1940s. Prior to the 1940s, however, deflation was more the norm than the exception.