Explain Inflation, Hyperinflation, Disinflation and Deflation

Inflation

Inflation is the persistent increase in the general price level of goods and services in an economy over a given period of time.  Fewer goods and services are bought when price levels rise hence the reduction in purchasing power. Also, the main measure of inflation is the inflation rate. Inflation rate is the percentage change in a price index. Unlike deflation, inflation is occasioned by the following circumstances:

• when money supply increases faster than the economic growth can sustain; or
• when large amounts of money are injected into the economy.

Inflation has its advantages and limitations.

Advantages

• Reduction in the amount of real private and public debt; and
• Increased employment because of nominal wage rigidity.

Limitations

• Increased opportunity cost of holding money;
• Discourages savings and investments; and
• Consumers begin amassing goods in fear of future rise in prices.

Hyperinflation

Hyperinflation is an extreme case of inflation where the inflation rate increases above 100%. During hyperinflationary periods, the price level increases by about 500% to 1000% per year. Here, prices cannot be controlled.

Hyperinflation happens when there is significant rise in money supply that cannot be supported by economic growth. As a result, supply and demand for money are at a disequilibrium.

Causes of Hyperinflation

• An imbalance between money demand and supply;
• Excess printing of currency by the central bank; and
• When people lose confidence in their country’s currency.

Effects of Hyperinflation

• Borrowers gain at the expense of lenders; and
• The public transfers wealth to the government.

Deflation

Deflation is a decrease in the price level due to reduced supply of money in an economy. Although it raises consumers’ purchasing power, deflation may have negative outcomes on economic stability and growth. During a period of deflation, the inflation rate falls below 0%.

Causes of Deflation

• Reduced money supply; or
• Increased economic productivity, which results in the production of more goods than there is demand for.

Effects of Deflation

• It discourages expenditure and investments; and
• It decreases aggregate demand.

Disinflation

Whereas deflation is negative economic growth, such a -5%, disinflation is simply a reduction in the inflation rate. For instance, the inflation rate can fall from 9% in one year to 7% in the next year. It occurs when the rate at which prices are rising is diminishing.

It is important to note that disinflation does not signal the slowing down of the economy’s growth; it signals a slow down in the growth rate of inflation.

Question

Which of the following statements is most likely accurate?

A. If the price of oil rises in an economy, the inflation rate increases

B. In a disinflationary environment, the overall price level declines

C. Deflation occurs when the inflation rates turn negative

Solution

The correct answer is C.

Deflation, or negative inflation, happens when prices fall because the supply of goods is higher than the demand for those goods.

Reading 15 LOS 15e:

Explain inflation, hyperinflation, disinflation, and deflation