Limited Time Offer: Save 10% on all 2021 and 2022 Premium Study Packages with promo code: BLOG10    Select your Premium Package »

Inflation, Hyperinflation, Disinflation and Deflation

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?

  1. Deflation occurs when the inflation rates turn negative.
  2. In a disinflationary environment, the overall price level declines.
  3. If the price of oil rises in an economy, the inflation rate increases.

Solution

The correct answer is A.

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

Featured Study with Us
CFA® Exam and FRM® Exam Prep Platform offered by AnalystPrep

Study Platform

Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Online Tutoring
    Our videos feature professional educators presenting in-depth explanations of all topics introduced in the curriculum.

    Video Lessons



    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.