Inflation and deflation are two major economic conditions that have an impact on the prices of goods and services. They can have important financial implications for consumers and businesses across the world. In this post, we will explore the differences between inflation and deflation and how they impact businesses, consumers, employment, and the economy as a whole.
Summary
- Inflation and deflation can both cause adverse economic effects on the economy
- Deflation occurs when there is an excess supply of goods and services along with a lack of money to purchase those goods and services
- Inflation is a measure of the rate of rising prices for goods and services
Understanding Inflation
Inflation is an economic measure of the rate of rising prices for goods and services in the economy. The impact of inflation causes a decrease in the overall purchasing power of consumers and is measured as a percentage. Inflation has a negative impact on both consumers and businesses as it makes the money you save today less valuable in the future.
If a country has a poor fiscal and monetary policy, inflation can quickly spiral out of control.
It can slow down economic growth, impact supply chains, employment, investments, retirement savings, and more. In addition, inflation can turn into stagflation, which is even worse. There are also different types of inflation that businesses and consumers should understand that can have an impact on their spending and saving.
Who Loses and Benefits From Inflation?
Inflation hurts consumers and the middle class that holds cash savings and who are on a fixed income. As the price of goods and services goes up their purchasing power decreases. The interest earned on savings accounts is significantly lower than the rate of inflation making their dollars worth less today than in the future.
On the contrary, inflation favors those who hold hard assets like real estate, land, gold, or silver. In addition, inflation also favors consumers and businesses who hold debt with lower fixed interest and fixed payments. During periods of high inflation, the value of the assets tends to increase. In other words, the rich get richer while the middle class suffers.
How Does Inflation Turn To Deflation?
It’s worth noting that deflation is not uniform. It can come into different industries while inflation remains in others. During deflation, you can still experience inflation in other areas of the economy that haven’t been hit yet.
For example, between 2019-2020 during the pandemic, we experience a significant drop in the price of oil but a surge in real estate prices. Real estate prices increased due to increased demand for housing and supply shocks to construction. This combination caused a deflation in one sector and inflation in another.
Negative Consequences of Long-Term Inflation
- Sustained inflation can lead to higher interest rates in the long run. With the current inflation levels sitting at all-time highs in the United States, the Federal Reserve is forced to take drastic measures and increase its federal funds’ rate in order to try and get inflation under control.
- Lower investment and savings. As the prices of goods and services increase consumers to save less money and put away less money into retirement.
- Inflation impacts equities markets. Short-term inflation can have a positive impact on the price of stocks. However, sustained inflation over the long term will naturally drag down stock prices as people invest less.
- Potential Tax Increases. Higher prices lead to an increase in taxes. This can include higher taxes on incomes, property taxes, and land and business income.
As you can see, the negative consequences of long-term inflation bear a heavy weight on the middle class. For people that are already rich, long-term inflation can actually benefit them.
Understanding Deflation
Deflation occurs when there is an excess supply of goods and services and a lack of money to purchase those goods and services. In a deflationary economy, the price of goods and services goes down. If a particular product becomes extremely popular and a high amount of competitors begin flooding the market to compete, other companies will have a higher supply than they can actually sell.
The increased supply on hand with a lower demand causes companies to have to drop their prices so they can stay competitive with the rest of the market. If deflation continues for a sustained period of time, it can slow down the economy as consumers are forced to cut down on their spending.
Main Causes of Deflation
To better understand deflation, it’s important to be aware of the different causes that contribute to it. There are six major causes of deflation:
- Reduced Consumer Demand
- Increased Competition
- Higher Productivity Levels
- Advancements in Technology
- Supply Shocks in Commodities
- Reduction in the Money Supply
All of these causes of deflation bear their own unique weight. They can be both positive and negative for the economy depending on the conditions under which they occur.
For example, as the production of electric vehicles increases, it will naturally push the price of oil down making. However, the supply of electric vehicles may not be able to meet the growing demand, and as such, the cost of electric vehicles is much higher for the average consumer.
Difference Between Inflation and Deflation
Inflation is a general rise in the prices of goods and services, while deflation is a drop in the price of goods and services. Both can carry a negative impact on the economy, however, they can also be positive under the right economic conditions.
Understanding when inflation and deflation are negative and when they are positive for consumers, can help them plan their spending and investing. However, if deflation and inflation are sustained over long periods of time their effects are negative.
Who Benefits and Who Loses from Deflation
In the short-term, deflation has an overall positive impact on the average consumer because of the reduced price of goods and services. It allows consumers to save more money and increases their purchasing power. During deflation, interest rates tend to go down which allows people to borrow money at lower rates.
However, long-term extended deflation can lead to higher unemployment rates and an overall slowing of the economy. In addition, it causes an overall decline in incomes and reduced consumer confidence. Long-term deflationary periods can be very bad for the economy. People with fixed incomes and people who get laid off are hit the hardest.
Conclusion
As an average consumer, it’s important to be aware of how economic inflation and deflation impact your spending and saving habits. Being educated can help you plan your finances accordingly as the overall economy shifts. Being on the right side of changing economic conditions can help you avoid making tough financial decisions and also help you avoid making poor financial decisions. Pay attention and choose wisely.
