The definitions of inflation and deflation

Jump to Current Inflation Table The inflation rate plays an important role in determining the health of an economy.

The definitions of inflation and deflation

Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. This in turn can be caused by an increase in supply, a fall in demand, or both. When prices are falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity.

When purchases are delayed, productive capacity is idled and investment falls, leading to further reductions in aggregate demand.

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This is the deflationary spiral. The way to reverse this quickly would be to introduce an economic stimulus. The government could increase productive spending on things like infrastructure, it could increase upper class taxes, or the central bank could start expanding the money supply.

Deflation is also related to risk aversionwhere investors and buyers will start hoarding money because its value is now increasing over time.

A central bank cannot, normally, charge negative interest for money, and even charging zero interest often produces less stimulative effect than slightly higher rates of interest. In a closed economythis is because charging zero interest also means having zero return on government securities, or even negative return on short maturities.

In an open The definitions of inflation and deflation it creates a carry trade, and devalues the currency.

Word Origin & History

A devalued currency produces higher prices for imports without necessarily stimulating exports to a like degree. Deflation is the natural condition of economies when the supply of money is fixed, or does not grow as quickly as population and the economy. When this happens, the available amount of hard currency per person falls, in effect making money more scarce, and consequently, the purchasing power of each unit of currency increases.

Deflation also occurs when improvements in production efficiency lower the overall price of goods. Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods.

Deflation - Wikipedia

When this happens, consumers pay less for those goods, and consequently deflation has occurred, since purchasing power has increased. Rising productivity and reduced transportation cost created structural deflation during the accelerated productivity era from —, but there was mild inflation for about a decade before the establishment of the Federal Reserve in Most nations abandoned the gold standard in the s so that there is less reason to expect deflation, aside from the collapse of speculative asset classes, under a fiat monetary system with low productivity growth.

In mainstream economicsdeflation may be caused by a combination of the supply and demand for goods and the supply and demand for money, specifically the supply of money going down and the supply of goods going up. Historic episodes of deflation have often been associated with the supply of goods going up due to increased productivity without an increase in the supply of money, or as with the Great Depression and possibly Japan in the early s the demand for goods going down combined with a decrease in the money supply.

Studies of the Great Depression by Ben Bernanke have indicated that, in response to decreased demand, the Federal Reserve of the time decreased the money supply, hence contributing to deflation.

The deflation was caused by the decrease in the production and distribution costs of goods. It resulted in competitive price cuts when markets were oversupplied.

The mild inflation after was attributed to the increase in gold supply that had been occurring for decades. By contrast, under a fiat monetary system, there was high productivity growth from the end of World War II until the s, but no deflation.

Persistent deflation was clearly understood as being the result of the enormous gains in productivity of the period. Debt deflation Debt deflation is a complicated phenomenon associated with the end of long-term credit cycles.

It was proposed as a theory by Irving Fisher to explain the deflation of the Great Depression. A historical analysis of money velocity and monetary base shows an inverse correlation: Additionally, the velocity of the monetary base is interest rate sensitive, the highest velocity being at the highest interest rates.

During financial crises many banks failed and their notes became worthless. Also, banknotes were discounted relative to gold and silver, the discount depending on the financial strength of the bank.

More recently Alan Greenspan cited the time lag as taking between 12 and 13 quarters. In a credit-based economy, a slow-down or fall in lending leads to less money in circulation, with a further sharp fall in money supply as confidence reduces and velocity weakens, with a consequent sharp fall-off in demand for employment or goods.

The fall in demand causes a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production, or repaying debt levels incurred at the prior price level.Recent Examples on the Web.

Recent innovations like ecommerce and fracking have strengthened deflation’s grip on prices, people, and jobs. — Dave Margulius, Fortune, "Commentary: Inflation Shook the Markets This Week—But Deflation Is the Force to Watch," 8 Feb. Inflation has remained subdued in the country, which has experienced decades of deflation and stagnation.

Deflation is caused either by increasing taxes and/or interest rates, or by cutting down on government spending. Although effects of deflation are opposite to that of inflation, certain costs (such as minimum pay) generally do not fall.

And, whereas inflation may or may not result in higher levels of output and employment, significant deflation always results in lower output and employment. Times, Sunday Times () Spain simultaneously needs both deflation and inflation. Times, Sunday Times () Is a financial crisis more likely to occur when the economy is experiencing deflation or inflation?

Mishkin, Frederic S. Financial Markets, Institutions and Money () In most advanced economies there is a bigger worry about deflation than inflation.

Synonyms for deflation at leslutinsduphoenix.com with free online thesaurus, antonyms, and definitions.

Find descriptive alternatives for deflation.

The definitions of inflation and deflation

For the UK, price stability means ensuring that the price level increases gradually, by an average of no more than 2% per year. The official target is 2%, though there is a safety margin of +/- 1%.

When the volume of money and credit falls relative to the volume of goods available, the relative value of each unit of money rises, making prices of goods generally fall. Though many people find it difficult to do, the proper way to conceive of these changes is that the value of units of money are rising and falling, not the values of goods. Both inflation and deflation are under control in the United States. The current inflation rate reveals where the economy is at in the business cycle. It's also measured by the Personal Consumption Expenditures price index, which includes more business goods and services than the CPI. Definition of deflation: A decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought.

Deflation occurs when asset and consumer prices fall over time. While this may seem like a great thing for shoppers, the actual cause of widespread deflation is a long-term drop in demand and most often signals an impending recession.

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