FACTBOX-What is deflation and why is it feared?

Nov 25 (Reuters) - Central bankers and international institutions have in recent weeks said the risk of deflation is rising, even though it is still small.

Such talk of deflation has reminded financial markets of Japan's decade-long struggle to escape an economic malaise dating from the mid-1990s that saw persistent declines in prices stifling attempts to kick-start economic growth.

The Organisation for Economic Cooperation and Development on Tuesday said there was a risk that slower growth would push Japan back into deflation in 2009, and on Nov. 12 Bank of England Governor Mervyn King said there was risk of deflation happening in the UK.

Central bankers in the euro zone and the United States have played down the risk of sustained deflation in their economies in recent days.

Here are some facts on deflation:

* WHAT IS DEFLATION?

-- Deflation is a prolonged and widespread decline in prices that causes consumers and businesses to curb spending as they wait for prices to fall further. It is the opposite of inflation, when prices rise, and should not be confused with disinflation, which merely describes a slowdown in the rate of inflation.

-- Deflation occurs when an economy's annual headline inflation indicator -- typically the consumer price index -- enters negative territory.

* WHY IS IT A PROBLEM?

-- As Japan found in the late 1990s and early 2000s, deflation is hard to shake off because it is self-reinforcing. Put simply, unless it is stopped early, deflation can breed deflation, leading to what is known as a deflationary spiral.

-- When an economy has fallen into deflation, demand from businesses and consumers to buy products dries up because they expect to pay less later as prices fall. But as producers struggle to sell and go bust, unemployment rises, reducing demand further. That causes deflation to become more pronounced.

-- As prices fall, the value of each unit of money increases. This makes it more expensive to service existing debts. This is as true of governments, who have borrowed trillions of dollars globally to prop up the financial sector, as it is for consumers.

-- As debt becomes more expensive to pay off, the risk of default and bankruptcy rises too, making banks more wary of lending. This reduces demand and further exacerbates the deflationary problem.

HOW HAS IT BEEN TACKLED IN THE PAST?

-- Tax cuts to boost demand from consumers and businesses

-- Lowering central bank interest rates to encourage economic activity

-- Printing more currency to boost money supply

-- Capital injections into the banking system

-- Increase government spending on projects that boost the return on private investment

COMMENTS BY POLICYMAKERS

MERVYN KING (BANK OF ENGLAND GOVERNOR), Nov 25

"When interest rates get to the zero-level -- if we ever were to get to that level and neither we nor the Americans have been at that level, Japan clearly got very close to it -- at that point there needs to be close coordination between government and the central bank because monetary policy is very close to government debt management." [ID:nKING]

(LORENZO BINI SMAGHI (ECB EXECUTIVE BOARD), Nov 25

"While a number of factors suggest that inflationary pressures will decline significantly, there are currently no signs of deflationary expectations."

"As long as inflation expectations remain firmly anchored, deflation will therefore remain a rather remote risk."

"The exhaustion of all ammunitions earlier in the process, when there is no evidence of a deflationary shock, reduces the margin of manoeuvre in case other adverse shocks occur."

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YVES MERSCH (ECB GOVERNING COUNCIL, BELGIUM), Nov 21

"I would not rule out that over one or two months we might have a falling price index."

"We have to look beyond such short-term falls in prices, just as we looked beyond short-term increases when commodity prices spiked."

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JAMES BULLARD (ST LOUIS FED PRESIDENT), Nov 20

"It would take some doing to get some deflation. But what I do think is the inflation expectations are very fluid right now, and that is one of the primary determinants of what is going to happen."

"If we do our job it won't happen and we're dedicated to that." <ID:nN20442980>

DONALD KOHN (FEDERAL RESERVE VICE CHAIRMAN), Nov 19

"My most likely outcome is for a couple of quarters of negative growth, and inflation coming down, but not getting to that deflationary state." <ID:nN19500018>

MASAKI SHIRAKAWA (BANK OF JAPAN GOVERNOR), Nov 21

"On whether price falls are causing any problems, I don't think there is a big danger of this happening. But I think policymakers of each country are examining their economies with the possibility of this in mind." <ID:nSP419742>

"We will closely watch the balance of domestic supply and demand and how people's price expectations develop."

Sources: Reuters/Worldbank (www.worldbank.org);/ IMF (www.imf.org)

(Writing by Carl Bagh, Editorial Reference Unit Bangalore, and Marilyn Gerlach in Frankfurt, editing by Tony Austin)