Inflation & Deflation- Meaning, Causes, Effects

The terms inflation and deflation are primarily used as we talk about macroeconomics, that is, the economy as a whole on a broader mindset. The two phenomena are observed almost in all economies around the globe. With this article, we will brief you on the basics of the two common terminologies: Inflation and deflation.

Inflation is where we face the price rise of goods and services. This decreases the purchasing power of the people in the economy. Deflation, on the contrary, is a situation opposite to inflation. It is a condition that leads to a decrease in the price of goods and services, which leads to an ultimate increase in the purchasing power of the people in the economy.

Most economies are facing the problem of inflation and deflation, hence, there needs to be equilibrium between them for an economy to function smoothly and to avoid a financial crisis on a macro level. But what exactly leads to such a situation, and what might be the causes of one of the most witnessed phenomena by most economies of the world? Understanding both inflation and deflation shall be the need of the hour for the important role it plays in the working of any economy. Well, to ease out, we have briefed everything for you in this article.

Inflation - Meaning

Inflation, to be precise, is the phenomenon that leads to an increase in the prices of goods, commodities, and services being traded within an economy. It usually impacts the buying capability of the end users of that economy. Inflation mostly leads to a price rise of essential goods like food items, clothes, commutation, households, etc. It decreases the purchasing power of the currency of the economy. On prima fascia, inflation appears to be a pessimistic situation but it has both merits and demerits.

Reasons for Inflation:

Several causes of inflation shall be assessed on a vast level to keep up with the impacts of inflation on the economy:

1. Excessive supply of money: Excess supply of money leads to inflation in the economy, this means that the total money supply inclusive of cash, coins, and other balances in banks increases at a faster pace than the rate of production of goods. Hence, making supply less and demand high for the same goods, making them expensive.

2. The demand for the goods/services: This happens when the rate of production of certain goods/ services is slow whereby the demand for such goods is higher, making them expensive within the market.

3. Cost of goods and services: Inflation also happens when the cost of production of certain goods and services is higher. Such fixed costs are often borne on by the ultimate users of the goods and hence, priced higher for the consumers causing inflation.

Merits of inflation:

The next portion would be to get an understanding of the facts that leads to the goodness of inflation:

1. Enhances economic growth:

To start with, at times of low inflation, the economy faces a recession. More precisely, a higher inflation rate can boost economic growth as it will demand more production of goods lacking within the economy.

2. Helps in adjustments of wages:

Some amount of inflation makes it easy to adjust the relative wages of the workers. Due to inflation, the average wage remains higher, it is easier to increase the wages of productive workers while the unproductive workers can have wages frozen leading to a good wage cut.

Demerits of inflation:

1. Inflation-oriented growth can be temporary:

The growth accompanying inflation happens to be unsustainable. The result of most such boom cycles is disturbing recession periods.

2. Inflation leads to lower investments and less lasting economic growth:

The reason for such discouraging investments and long-term growth is due to prolonged uncertainties in the financial environment due to inflation.

3. Inflation makes the economy uncompetitive and reduces the value of savings:

One of the causes of inflation is the devaluation of the currency of the economy facing inflation, thereby, making the economy uncompetitive as a whole. Also, due to the fall in the value of money, the valuation of savings remains low.

Deflation - Meaning

Deflation can be defined as a phenomenon wherein the price of goods, commodities, and services decease in an economy. It leads to an increase in the buying power of the people of an economy. In simpler terms, the people of the economy are able to purchase more quantities of products with confined money.

Reasons for deflation:

1. Increased rate of production:

Sometimes, certain goods and services witness a fast-paced production rate and thereby, leading to lower prices of goods and services. This would impact the other relative goods and commodities, hence affecting the whole economy.

2. Decreased supply of currency:

Another reason for deflation could be limited resources to purchase. When the supply of currency will decrease, the prices of goods and services also decrease and thereby making the products purchasable.

3. The level of competition within the suppliers in the market:

When many companies with similar goods compete for buyers, they tend to lower the prices of goods and services to make them readily available.

What are the effects of inflation & deflation?

To start with inflation, during inflation, the purchasing power of the economy decreases for the prices of commodities and services increase. Hence, when inflation is high, the cost of living also remains high, which ultimately means slow-paced economic growth.

Deflation too has its effects on the economy like reduced business revenues and lowered wages. In an economy facing deflation, businesses are compelled to lower the prices to match the competition to survive and stay profitable. This leads to reduced business revenues. Also, when revenue goes down, businesses need to cut out their fixed costs and hence reduction in wages and jobs consequently.

How to keep up with the effects of inflation & deflation?

Understanding inflation and deflation are essential for people living in an economy so as to reduce the aftermath consequences of the two phenomena. The processes are continuous and keep affecting the economy. One shall definitely keep themselves equipped through financial planning to mitigate the effects of inflation or deflation when required. Let's check out some ways to reduce the effects of inflation or deflation:

1. Plan out some long-term investments:

The very first step shall be to seek out some better long-term investment options. This would ensure your future growth along with the best that money is well spent today.

2. Make way for savings:

Your future is unpredictable and would require more money when you go old. Another way to cope with inflation and future requirements would be to seek some savings options that would give better returns along with good savings.

3. Make a portfolio instead of one sole investment option:

You shall also understand the fact that investment in one single type of investment would lead to something riskier than rewarding. So you shall invest your money in different investments.

Conclusion:

To conclude, most economies work along with their Banking system to control the overall inflation prevailing in the economy. RBI keeps an eye on the inflation rate by adjusting interest rates. Inflation and deflation shall thereby be termed as parallel going for an economy to be successful in its financial working. Keep following us for more articles on finance and commerce.