Inflation and Deflation: Impacts and Effects
Inflation
Inflation is the rate of increase in prices for goods and services.
It influences the interest rate we get on our savings and the rate we pay on our mortgages. Inflation also affects pensions, benefits, and the price of some train tickets.
Effects of Inflation
- Redistribution Effect:
- Affects recipients of fixed income (nominal incomes remain the same, but the real value drops).
- Affects the purchasing power of wages that don’t follow the rise of prices.
- Diminishes the value of loans and savings.
- Social Impact: Socially disadvantaged individuals suffer from inflation more than the wealthy.
- Impact on Economic Balance:
- Real product falls below potential product.
- Changes in the structure of consumption (consumers buy cheaper goods).
- In cases of fixed currency exchange rates, higher exports are incited.
- Inflation deforms prices.
- Inflation causes higher costs and makes the economy less efficient.
High Inflation
Makes exports less competitive and reduces demand for currency.
Hyperinflation
Hyperinflation is an extremely rapid period of inflation, usually caused by a rapid increase in the money supply. Money loses its value so rapidly that no one wants to use it as a medium of exchange.
Hyperinflation starts when a country’s government begins printing money to pay for spending. As the money supply increases, prices rise as in regular inflation. During hyperinflation, people exchange any cash they have for physical goods (whether they need them or not) because they know the money will be worth less tomorrow.
Deflation
Deflation is a fall in the general price level. It is a negative rate of inflation.
It means the value of money increases rather than decreases.
Deflation is not necessarily bad, but periods of deflation or low inflation can lead to economic stagnation and high unemployment. This is because deflation can discourage spending (as things will be cheaper in the future) and increase real debt burdens, reducing the spending power of firms and consumers.
Deflation is only good if prices are falling and your disposable income is rising.
Problems of Deflation
- Discourages Consumer Spending: Falling prices often encourage people to delay purchases. Therefore, deflation often leads to lower consumer spending and lower economic growth.
- Increases Real Value of Debt: Deflation increases the real value of money and debt, making it more difficult for debtors to repay. Consumers and firms have to spend a bigger percentage of disposable income on meeting debt repayments (in a period of deflation, firms will also be getting lower revenue, and consumers will likely get lower wages). This leaves less money for spending and investment.
- Real-Wage Unemployment: In periods of deflation, real wages rise. This could cause real-wage unemployment.