Inflation Ups and Downs

When prices go up, there’s panic. When prices go down, everyone celebrates. But there’s more nuance to the price of goods and services. Here’s what to know about inflation.

What is Inflation?

Inflation occurs when the overall price of goods and services increases over time, reducing the purchasing power of money. When the demand for goods and services outpaces supply, prices rise. As inflation rises, each dollar buys fewer goods and services, decreasing the value of money. While a moderate level of inflation is common in a growing economy, high inflation can lead to economic instability and make it harder for people to afford everyday items.

Causes of Inflation

• Demand-pull inflation happens when demand for goods and services is higher than what’s available, pushing prices up.
• Cost-push inflation. This occurs when the cost of making goods (like labor or materials) goes up, so businesses raise their prices to cover the extra costs.
• Built-in inflation: When businesses raise prices to keep up with higher wages, and workers, in turn, ask for higher wages to keep up with rising prices. It’s a cycle that keeps pushing prices higher.

Effects of Inflation

• If real wages don’t keep up with price increases, savings could decline.
• May lead to higher interest rates.
• Reduced purchasing power.

Deflation

Deflation is the decrease in the general price level of goods and services. It is the opposite of inflation, where prices fall and the purchasing power of money increases. While it might seem like a good thing on the surface, deflation can signal underlying economic problems.

Causes of Deflation

• Decreased money supply
• Decline in consumer demand, causing businesses to drop prices to encourage sales.

Effects of Deflation

• Reduced consumer spending, as people wait for lower prices.
• Economic recession, as businesses cut back on production or investment.

Which is Better?

You would think that deflation is better than inflation; after all, we all want prices to be low, right? Well, that’s generally not the case. Moderate inflation is seen as the best situation for the economy, as it encourages spending and prices are not out of control. When deflation occurs, especially over a long time, people hold onto their money as they think prices will keep dropping. That hurts the economy overall.

Do One Thing: Keep an eye out for rapid inflation or deflation, as both can have a negative impact on the economy.