Difference Between Inflation and Deflation
Inflation means the increase in the prices of general goods and services. Deflation, on the other hand, means the decrease in the prices of goods and services. Hence inflation and deflation are the two of the same coin and form an integral part to maintain the economic stability of an economy.
In this article, we look at Inflation and Deflation in detail.
What is Inflation?
The purchasing power of the Dollar is determined by the number of goods or services that money can buy. The purchasing power of the Dollar decreases as inflation increases. Thus a person will have to spend more in order to buy only a little. This also causes a rise in gold prices.
What is Deflation?
Deflation is the opposite of inflation, where the prices of goods and services are falling. It can be also termed as negative inflation since the inflation rate is less than 0%.
Since the prices are following a downward trend, the purchasing power of the money increases. That is, people are able to buy more with less money.
One may think that deflation is good as the prices of goods are low and people can buy more. But a continued deflation is not for the economy. If the prices keep dropping, the consumers will not buy the goods expecting and waiting for the prices to drop further. Companies suffer losses if their goods aren’t sold and as a cost-cutting exercise, lay-off their employees. When people are unemployed, they spend even less. They may even default on their loans or credits and other obligations. Due to this, the bad debts of the banks increase. These banks reduce the number of loans sought by creditors thus, in turn, reducing the liquidity in the economy. Thus, deflation is a vicious cycle.
Inflation vs Deflation Infographics
Key Differences Between Inflation and Deflation
The key differences are as follows –
#1 – Cause of Inflation and Deflation
- Excess money: Excess of money or currencies is one of the major causes of inflation. When the money supply in the country grows above economic growth, the value of the currency decreases.
- Demand-pull: Due to an increase in the demand for goods and services, the suppliers may increase the prices.
- Cost-push: When companies face an increased cost of production, they may increase the prices of the goods in order to maintain their profit margin.
- Efficient production: Technological innovations make the production of goods more efficient, leading to a drop in prices.
- The decrease in the supply of currency: This will lead to a decrease in the prices of goods and services to make the product affordable to the mass.
#2 – Measurement of Inflation and Deflation
- In India, measurement of inflation is done with the help of Consumer Price Index (CPI – computes the changes in the general price level of a class of consumer goods) and Wholesale Price Index (WPI – measures the average change in prices received on the bulk sale of goods)
- When the change in prices in one period is lower than in the previous period, the CPI index has declined, indicating that the economy is experiencing deflation.
#3 – Effects of Inflation and Deflation
- In the case of salaried persons, if the percentage raise is less than the rate of inflation, then it is effectively not rising in the true sense because it does not preserve the purchasing power of your money.
- If inflation in a country is higher than that in its trading partner countries, then the cost of goods for that country is higher than the imported goods.
- When the customers postpone their consumption and purchasing of goods and services, it affects both, the micro, and macroeconomic factors. Due to this, the investment is suspended leading to recession, depression, an increase in the unemployment rate, etc.
#4 – Safeguarding
- One of the best ways to secure oneself from inflation is to park your money in long-term investments where the rate of return is higher than the average inflation rate. The stock market and mutual funds would fit these criteria. On the other, the average rate of return on a savings account is generally lower than the average rate of inflation.
- Deflation is rare and it also doesn’t last very long. Since deflation can have adverse effects on the economy, the government quickly takes corrective measures.
Inflation vs Deflation Comparative Table
|Definition||The prices of goods and services increase||The prices of goods and services decrease|
|Explanation||Value of the money decreases in the international market||Value of the money increases in the international market|
|Types||Demand-pull inflation, cost-push inflation, and stagflation||Money supply-side deflation, credit deflation, and debt deflation|
|Effect||Unequal distribution of income||The unemployment level increases|
|Which is worse?||A bit of inflation is good for the country/ economy||Deflation is not good for the country/ economy|
|Safeguarding||Long-term investments||Usually, the government does not let deflation to prevail|
An inflation rate of 2-3% is usually considered to be good for economic growth. But a continued decrease in prices leads the economy into a spiral of severe crisis. The government takes steps to keep both, inflation and deflation in check
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