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THE CONCEPT OF INFLATION AND DEFLATION: WHICH IS WORSE FOR THE
ECONOMY?
E.A. Abdullaev, Student
Northern (Arctic) Federal University named after M.V. Lomonosov (Russia, Arkhangelsk)
DOI:10.24412/2411-0450-2024-6-1-6-11
Abstract. The article examines two key economic phenomena - inflation and deflation, and also analyzes their causes, types and consequences for economic stability. Inflation is defined as a persistent increase in prices that reduces the purchasing power of money. Deflation, on the other hand, is a decrease in the general price level, which, although it increases the purchasing power of money, can lead to negative consequences such as economic stagnation and increased unemployment. The article also discusses in detail the main causes of inflation and deflation. The article concludes by comparing the economic impacts of inflation and deflation, emphasizing that each presents unique issues and challenges. Inflation can lead to loss of purchasing power, uncertainty, income redistribution and reduced competitiveness. Deflation can contribute to the emergence of a debt trap, a reduction in production and investment costs, and increased economic stagnation. The author comes to the conclusion that both phenomena require a careful approach on the part of decision makers in the field of economic policy in order to minimize their negative impact on the economy.
Keywords: inflation, deflation, purchasing power, measures, costs, politics.
In the world of economics, the phenomena of inflation and deflation occupy key positions among the factors influencing economic well-being and stability. These terms often appear in the news and are discussed by politicians, economists and ordinary citizens. However, to truly understand their significance, it is necessary to delve into the nature of these processes, their causes, consequences and how to manage them.
Inflation and deflation are two opposing phenomena that reflect changes in the price level of goods and services. When we talk about inflation, we mean a constant rise in prices, which reduces the purchasing power of money. Deflation, on the other hand, is a sustained fall in prices that increases the purchasing power of money but, paradoxically, can lead to negative consequences for the economy [1]. Both situations cause significant changes in the economic behavior of citizens, businesses and the state and require a careful approach on the part of those responsible for economic policy.
The concept of inflation, its types and causes.
Inflation is a complex economic phenomenon that has a significant impact on people's
daily lives and the economic stability of the country. It represents a steady increase in the general level of prices for goods and services, which leads to a decrease in the purchasing power of money. This means that the same amount of money can buy fewer goods and services over time. Inflation is measured by various indices, such as the Consumer Price Index (CPI) and Producer Price Index (PPI), which track changes in the prices of specific sets of goods and services.
Inflation is divided into several types depending on the rate of price growth. Each of these types has its own characteristics and has a different impact on the economy.
Let's look at the main types of inflation:
- natural inflation (or creeping inflation) is a slow and predictable increase in prices, usually within 1-3% per year. This type of inflation is considered normal for a healthy economy and does not cause significant economic disruption. In conditions of natural inflation, prices rise slowly, which allows business entities to easily adapt to changes.
An example of natural inflation can be seen in most developed countries, where central banks aim to keep inflation at around 2% per year. Such inflation stimulates economic
activity by encouraging consumers and businesses to spend and invest as expected small price increases reduce the incentive to save.
- moderate inflation is characterized by a more noticeable increase in prices, usually within 3-10% per year. While this level of inflation is still manageable, it is beginning to have a more significant impact on the economy and may cause concern among consumers and businesses. Moderate inflation can be associated with economic growth when demand for goods and services exceeds supply.
An example of mild inflation can be seen in developing countries or during periods of rapid economic growth when production capacity cannot meet increasing demand. In such conditions, enterprises may reconsider their pricing strategies and contracts, and investors may become more cautious, which is reflected in the level of capital investment in the economy.
- galloping inflation is a rapid and significant increase in prices, usually in the range of 10-50% per year. This phenomenon is already considered a major problem for the economy as prices are rising too quickly, making long-term planning and business difficult. Galloping inflation is often accompanied by economic instability and increased risks for investors and creditors.
An example of runaway inflation can be seen in some developing countries that are experiencing economic shocks or structural changes. In such an environment, prices for goods and services may change monthly or even weekly, creating significant uncertainty for all participants in the economy [2].
Hyperinflation is an extreme form of inflation in which prices rise extremely quickly, usually by more than 50% per month. This phenomenon is destructive to the economy and society, since money almost completely loses its value. Hyperinflation leads to the collapse of the monetary system, mass poverty, unemployment and social instability.
An example of hyperinflation can be seen in Zimbabwe in the late 2000s, when inflation reached astronomical levels and prices doubled every day. Under such conditions, money loses its function as a means of exchange and accumulation of value, which leads to serious social and economic upheaval.
Let's look at the main reasons for inflation:
1. Excess demand
Excess demand is one of the main causes of inflation and occurs when aggregate demand for goods and services exceeds aggregate supply. This causes prices to rise as producers cannot quickly increase production to meet increased demand. Excess demand can arise for several reasons:
- Economic growth: during periods of economic growth, household incomes rise, which stimulates consumer spending and investment.
- Fiscal policy: government measures to stimulate the economy, such as tax cuts or increased government spending, can lead to an increase in aggregate demand.
- Credit expansion: easy access to credit and low interest rates promote growth in consumer demand and investment.
Example: In the 1960s in the United States, a period of economic growth and increased government spending led to an increase in the demand for goods and services, leading to inflation.
2. Rising production costs
Rising production costs are another important cause of inflation. When the costs of producing goods and services increase, producers pass on these increased costs to end consumers in the form of higher prices. Main factors contributing to rising costs:
- Rising commodity prices: sharp rises in the prices of basic resources such as oil, metals or grains increase production costs.
- Wage growth: increasing workers' wages without a corresponding increase in labor productivity leads to rising costs.
- Energy crises: rising prices for energy resources, such as oil and gas, have a significant impact on production costs.
Example: The energy crisis of the 1970s, caused by soaring oil prices, led to significant increases in costs in many industries and, as a result, to inflation.
3. Monetary policy
Monetary policies of central banks play a key role in managing inflation. If the central bank issues too much money or cuts interest rates too low, this can lead to an increase in the money supply in the economy and there-
fore inflation. Main aspects of monetary policy affecting inflation:
- Excess supply of money: excessive increase in the money supply in the economy leads to a decrease in the value of money and an increase in prices.
- Low interest rates: lower interest rates stimulate consumer spending and investment, which increases aggregate demand and can cause inflation.
4. External factors
External economic shocks, such as sharp increases in the prices of imported goods or depreciation of the national currency, can lead
to inflation. Main external factors influencing inflation:
- Rising prices for imports: rising prices for imported goods lead to rising domestic prices for products.
- Currency depreciation: depreciation of a nation's currency increases the cost of imported goods and services, leading to inflation.
- Global economic events: global economic crises, wars and natural disasters can disrupt supply chains and cause prices to rise.
Example: The devaluation of the ruble in Russia in 2014 led to an increase in prices for imported goods, which contributed to rising inflation (table 1).
Table 1. Official ruble exchange rate established by the Bank of Russia at the beginning of the
corresponding year, rubles
2015 2014 2013
Rate against US Dollar 56,19 32,56 30,35
Exchange rate against Euro 68,38 45,00 40,22
As can be seen from the table, over the past year the ruble has depreciated against the dollar by 1.72 times. For comparison: for the previous annual period (2013-2014), depreciation was only 1.08 times. In relation to the euro, the rate of depreciation of the ruble was 1.52 and 1.12 times, respectively.
The concept of deflation, its types and causes.
Deflation is a decrease in the general level of prices for goods and services in the economy over a long period. This phenomenon is the opposite of inflation and is usually associated with a contraction in the money supply and a decline in aggregate demand. While deflation may seem beneficial to consumers due to lower prices, it is often accompanied by serious economic problems such as decreased production, rising unemployment, and economic stagnation [3].
Main characteristics of deflation:
- Decline in the general price level: deflation manifests itself as a sustained fall in the consumer price index (CPI) or other measures of inflation.
- Increase in the purchasing power of money: in deflation, the value of money increases because the same amount can buy more goods and services.
- Decrease in the money supply: deflation is often associated with a decrease in the amount of money in circulation, which can be the result of tight monetary policy or an economic crisis.
Deflation can manifest itself in various forms, depending on the reasons for its occurrence and the nature of its impact on the economy. Let's look at the main types of deflation:
1. Price deflation
Price deflation is a type of deflation in which a decrease in prices for goods and services occurs due to a decrease in aggregate demand. When consumers and businesses start spending less, demand for goods and services falls, causing prices to fall.
Example: During the Great Depression of the 1930s in the United States, demand for goods and services fell sharply, causing prices to fall significantly.
2. Credit deflation
Credit deflation occurs as a result of a reduction in lending and a decrease in the money supply in the economy. When banks reduce lending and borrowers reduce their debt obligations, this leads to a decrease in the money supply and lower prices.
Example: During the 2008 financial crisis, many banks restricted lending, which contributed to deflationary processes in some countries.
3. Technological deflation
Technological deflation is caused by the
development of new technologies and increased labor productivity, which leads to lower production costs and, accordingly, lower prices for final goods and services.
Example: Advances in information technology and industrial process automation have helped lower the prices of electronics and other technology products in recent decades.
4. Export deflation
Export deflation is associated with changing conditions in world markets. If a country whose economy is largely dependent on exports experiences a decrease in demand for its exports, this can lead to deflationary processes within the country.
Example: The fall in world oil prices in the mid-2010s led to a decrease in the income of oil-exporting countries and caused deflationary trends in these economies.
The main causes of deflation are related to the dynamics of aggregate supply and demand, monetary policy, financial crises and consumer and business expectations. Let's look at these reasons in more detail:
- Reduction in aggregate demand;
Declining consumer and investment spending is one of the main causes of deflation. When consumers start saving more and spending less, this leads to a fall in demand for goods and services. Economic downturns, such as recessions and depressions, are often accompanied by increased uncertainty, causing people to save money for a rainy day by cutting back on current spending. High unemployment also leads to lower incomes, which reduces purchasing power. When companies see a decline in demand for their products, they also reduce their investments, exacerbating the decline in aggregate demand.
- Increase in aggregate supply;
Deflation can also result from an increase
in the aggregate supply of goods and services when demand is stable or declining. The development of new technologies and increased labor productivity reduce production costs,
which can lead to excess supply. When production capacity expands and output increases, but demand does not increase proportionately, it creates pressure on prices, which begin to decline. In such conditions, enterprises are forced to reduce prices in order to stimulate demand and sell their products.
- Tight monetary policy;
The monetary policy of central banks plays a key role in controlling the price level in the economy. Deflation can result from tight monetary policy aimed at reducing the money supply and lowering inflation expectations. Central banks can raise interest rates and limit the money supply to fight inflation. In such conditions, borrowing becomes more expensive and access to credit decreases. This leads to lower consumer and investment spending, lower aggregate demand, and ultimately deflation.
- Financial crises;
Financial crises are often accompanied by deflationary processes. During a crisis, trust in financial institutions decreases, and banks may limit the issuance of loans. Borrowers, in turn, seek to reduce their debt obligations, which leads to a decrease in the money supply in the economy. Declining confidence and reduced lending lead to a fall in consumer and investment spending, which causes a decline in aggregate demand and deflation. During a financial crisis, the number of insolvent enterprises and unemployed people also increase, which exacerbates deflationary trends.
- External factors
External economic shocks can also cause deflation. For example, a sharp decline in world prices for key export goods or currency depreciation can lead to deflationary processes. If a country is heavily dependent on exports, a fall in external demand for its products can lead to lower domestic incomes and deflation. Likewise, a stronger currency makes imported goods cheaper, which can help lower the overall price level within a country. Global economic events such as economic crises, wars or natural disasters can disrupt supply chains and create conditions for deflation.
Inflation and deflation: which is worse for the economy?
Inflation and deflation are two opposing economic phenomena, each with their own unique consequences and problems for the economy. Let's take a closer look at how each of these factors affects the economy and why they can be problematic [4].
Inflation is characterized by a steady increase in the price level of goods and services over time. Here are the key aspects that make inflation a problem for the economy:
- Loss of purchasing power: constantly rising prices mean that money becomes less valuable over time. People and businesses may buy fewer goods and services for the same money, lowering their standard of living and reducing their ability to save.
- Uncertainty and instability: high levels of inflation create uncertainty in the economy, making long-term planning difficult for both households and businesses. Consumers face the risk of losing purchasing power even in the near future, which could deter their spending and investment.
- Redistribution of income: high inflation often leads to redistribution of income in the economy. People on fixed incomes, such as retirees or people earning wages that do not correlate with inflation, may fall victim to a decline in their purchasing power. At the same time, those who own inflation-protected assets (such as real estate or securities) can increase their wealth, thereby increasing social inequality.
- Deteriorating competitiveness: high inflation can reduce the competitiveness of a country's exports. This is because domestic product prices can undermine the ability of exporters to offer competitive prices in world markets, which negatively impacts the country's balance of payments.
Deflation is also a problem and is a continuous decline in the price level of goods and services in the economy. Here are the main problems associated with deflation:
- Debt Trap: In a deflationary environment, the real value of debt increases, which can create problems for borrowers. Borrowing rates may remain the same or even rise, making debt servicing more difficult. This is especially important for businesses that may face increased debt obligations and decreased profitability.
- Threat of economic stagnation: deflation could lead to a decline in consumer demand and investment. Consumers and businesses may delay spending in anticipation of further price declines, which in turn worsens the deflationary spiral. This could lead to economic stagnation and recession.
- Capital flight and disinvestment. deflation can reduce investment returns and make new projects and businesses less attractive. Investors may prefer to keep money in cash rather than invest it in the economy, which could lead to deterioration in business activity and capital flight.
- Ineffective monetary policy: central banks may face limited tools to combat deflation. Lowering interest rates may not be effective because already low rates may not be sufficient to stimulate consumer demand and investment.
Conclusions
Inflation and deflation represent two extremes in the economy, each of which carries its own threats and problems. Inflation can undermine price stability, reduce purchasing power and worsen social inequality, especially if incomes do not rise at the same rate. While deflation, although seemingly benign (as prices fall), can cause serious problems such as an increase in the real cost of debt, a decline in investment and consumer spending, and economic stagnation.
To maintain a healthy economic environment, it is important to strive for moderate inflation. Moderate inflation (usually around 2-3% per year, depending on the country) is considered healthy and promotes economic growth and stability. It stimulates consumption and investment, encourages entrepre-neurship and job creation. In addition, moderate inflation helps avoid problems associated with debt and economic inefficiency that can arise in deflationary or high inflation environments.
Therefore, striking the right balance and keeping inflation under control plays a key role in maintaining the sustainability and health of the economy, providing an enabling environment for both consumers and businesses.
References
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2. Bordo M., Filardo A. Deflation in a historical Perspective BIS Working Papers № 186 November 2005. - URL: http://www.bis.org/.
3. Economics: a textbook for students of higher educational institutions studying in non-economic areas / E.A. Kapoguzov, G.M. Samoshilova, A.L. Karpov and others; under total ed. E.A. Kapoguzova; Omsk State University named after F.M. Dostoevsky. - Omsk: Omsk State University named after F.M. Dostoevsky, 2019. - 244 p.
4. Afanasyeva O.I. On inflation targeting and regulation of the ruble exchange rate // Banking. - 2017. - №4. - P. 7-14.
ПОНЯТИЕ ИНФЛЯЦИИ И ДЕФЛЯЦИИ: ЧТО ХУЖЕ ДЛЯ ЭКОНОМИКИ? Э.А. Абдуллаев, студент
Северный Арктический федеральный университет имени М.В. Ломоносова (Россия, г. Архангельск)
Аннотация. Статья рассматривает два ключевых экономических явления, инфляцию и дефляцию, анализируя их причины, виды и последствия для экономической стабильности. Инфляция определяется как устойчивый рост цен, который снижает покупательную способность денег. Дефляция, напротив, представляет собой снижение общего уровня цен, что, хотя и увеличивает покупательную способность денег, может привести к негативным последствиям, таким как экономическая стагнация и рост безработицы. Статья так же подробно обсуждает основные причины инфляции и дефляции. В заключение статья сравнивает последствия инфляции и дефляции для экономики, подчеркивая, что каждое из явлений представляет уникальные вызовы и проблемы. Инфляция может привести к утрате покупательной способности, неопределенности, перераспределению доходов и ухудшению конкурентоспособности. Дефляция же может способствовать возникновению долговой ловушки, снижению производственных и инвестиционных расходов, а также усилению экономической стагнации. Автор приходит к выводу, что оба явления требуют внимательного подхода со стороны экономических политиков для минимизации их негативного влияния на экономику.
Ключевые слова: инфляция, дефляция, покупательная способность, меры, издержки, политика.
