For decades, the conventional wisdom among corporate financial officers was that they could lower their companies’ costs by financing purchases of capital by borrowing—taking out loans from banks, selling commercial paper, issuing new bonds, and the like. The reason is that debt has traditionally been less expensive to a firm than issuing new shares. Corporate managers count on inflation to erode the value of the firm’s debts even as the selling price of the company’s output increased.

In a deflationary environment, however, these dynamics are reversed. Deflation increases the real value of outstanding debts. At the same time, companies find that to repay their loans, they must dip into profits that are declining. In 1997 and 1998, companies based in Southeast Asia faced lower selling prices and mounting real values of their indebtedness. In addition, the relative values of their currencies fell, and many of their debts were denominated in dollars. In addition to a rising real value of their debts in local currency, they also had to use more units of it to buy dollars to pay off their dollar indebtedness. 

In the past few years, U.S. manufacturing companies have been seeing their selling prices declining. Corporate treasurers in these industries are now talking about a new balance sheet paradigm in which companies will rely much more heavily on issuing stock instead of borrowing.

In what ways might deflation affect an individual’s well-being?