Difference Between Inflation vs Deflation
Macroeconomics of any country does not move in a constant manner. It is a cyclical process, wherein an economy grows, reaches its peak and falls again. This phenomenon is called Business cycle; which is closely followed by the central banks to adjust its monetary policy according to the cycle. Thus, when studying business cycles, it is important to understand the movement of prices of real goods in an economy, as it has a direct impact on the monetary policy of the country. The rise and fall in the price levels of real goods in the economy are called Inflation and Deflation respectively.
Inflation: Inflation refers to the significant increase in the general prices of real goods in the economy. Economists use various price indexes to study this phenomenon. Some of the common indexes that are used to understand the change in prices are Consumer price index, Wholesale price index, and Personal consumption expenditure price index. Moderate growth in the Inflation rate is healthy for the economy, however, if not monitored properly, it can cause serious damage to the economy. The two main causes of Inflation are:
- Demand-pull Inflation: Demand-pull inflation occurs when the aggregate demand for goods is more than the aggregate supply. When too much money chases few goods, suppliers raise the prices in order to benefit from the rising demand.
- Cost-push Inflation: Cost-push inflation is a scenario where the increase in the prices of factors of production leads to a significant increase in the cost of the goods, thus prompting suppliers to raise the prices.
There have been instances in the world economy, where certain countries at times witnessed an extremely fast increase in their inflation rates. This phenomenon is called “Hyperinflation”. Under Hyperinflation, the inflation grows at unusual rates of 500% – 1000%. Currently, Venezuela is experiencing such a high inflation rate.
Deflation: Deflation is a phenomenon where aggregate price level decreases significantly, which often leads to a negative inflation rate. An Inflation rate less than 0% is described as Deflation; therefore to avoid such a negative rate, central banks do not allow the inflation to fall below a certain standard rate. The consensus on standard inflation rate in developed countries is around 2%, and the central banks ensure that the rate does not fall below 2% by interfering through its monetary policy. During Deflation, as the price levels fall, companies typically experience fall in their revenues leading to increased debt levels. The companies short of enough cash cut its spending, investments, and labor; lower investments, spending and increased unemployment further deteriorate the economy leading to recession.
The reason why Deflation is considered as bad for the economy is that of the immense amount of damage it causes to the economy. As companies experience less profitability due to lowering prices, they spend and invest less. As prices keep falling, consumers delay their purchases so as to buy even cheaper when a price falls further. This leads to a further decline in demand prompting companies to slash prices even more.
The fall in the Inflation rate is not always considered as Deflation. A decline in inflation rate, such as from around 10% – 15% to 4% – 5% is termed as Disinflation. Disinflation is different from Deflation because inflation rate during disinflation is still positive even after falling dramatically.
Inflation vs Deflation Infographics
Below is the top 6 difference between Inflation vs Deflation
Key Differences Between Inflation vs Deflation
Both Inflations vs Deflation are popular choices in the market; let us discuss some of the major Difference between Inflation vs Deflation:
- Inflation leads to a decrease in the value of money, whereas Deflation leads to an increase in the value of money.
- The moderate inflation rate is healthy for the economy; on the other hand, Deflation causes the economy to deteriorate.
- Inflation is considered beneficial to the producers, while Deflation is considered beneficial to consumers.
- A 2% Inflation rate is considered healthy for the economy, whereas the Inflation rate is negative (below 0%) during deflation.
- Inflation is primarily caused by Demand and supply factors; on the other hand, Deflation is caused by Money supply and credit factors.
- Inflation leads to uneven distribution of money, whereas Deflation leads to a reduction in spending and an increase in unemployment.
Head to Head comparison Between Inflation vs Deflation
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As you can see there are many Comparison between Inflation vs Deflation. Let’s look at the top Comparison between Inflation vs Deflation –
|The basis of comparison between Inflation vs Deflation||Inflation||Deflation|
|Meaning||Inflation refers to the increase in the aggregate price level in the economy.||Deflation refers to the decrease in the aggregate price level in the economy.|
|Causes||Inflation caused by Demand factors is called “Demand-pull inflation”, whereas inflation caused by supply factors is called “cost-push Inflation”.||Deflation caused by a reduction in money supply is called “Money supply-side deflation”, whereas Deflation caused by credit factors is called “Credit deflation”.|
|Benefits||Moderate Inflation is considered beneficial to the economy. Inflation is considered beneficial for the producers of goods and services.||Deflation is considered as bad for the economy. Deflation is considered beneficial for consumers.|
|Rate||Inflation in developed countries is maintained around 2%.||Deflation occurs when the Inflation rate falls below 0% leading to the negative inflation rate.|
|Impacts||Inflation leads to a reduction in the purchasing power of money.||Deflation leads to an increase in the purchasing power of money.|
|Consequences||Inflation results in unequal distribution of money.||Deflation gives rise to a reduction in investment and spending by companies, as a result, unemployment rises.|
Inflation vs Deflation – Final Thoughts
The economy always follows a cyclical process which is constantly monitored by the central banks in order to adjust the interest rates according to the cycle. The cycles of the economy cannot be controlled; however, the effect of the cycles can be controlled to the marginal extent by central bank intervention. When the Inflation rate rises above a certain level where central banks feel the economy is overheating, they raise the interest rate in order to reduce demand thereby cooling down the economy.
Similarly, when the inflation rate falls below a certain level where central banks feel the economy is slowing down; interest rates are lowered in order to increase the demand thereby reviving the economic growth.
This has a been a guide to the top differences between Inflation vs Deflation. Here we also discuss the Inflation vs Deflation key differences with infographics, and comparison table. You may also have a look at the following articles