Relationship between inflation and deflation economy

Inflation - Wikipedia

relationship between inflation and deflation economy

Inflation vs deflation and what benefits to knowing? Monetary Inflation: This happens when there is too much money in an economy. to curb inflation or stimulate an economy out of a deflation. .. United States, as will be shown in a graph showing the relationship between inflation rates and. OECD Consumer Price Index · United States Bureau of Labor Statistics Inflation Calculator, Time value of money calculator based on Economics Deflation · Demand for money · Demand shock · Depression.

At least, they do not do so if the nominal quantity of money and the money wage rate are both free to vary. This is because rising prices and wages are incomes to some groups, as well as costs to others.

While it is therefore possible for an inflation to continue forever, this seldom happens, because the inflationary process reduces the level of real expenditures in one or more of the following ways: Effects on income claims. The process of inflation will affect the ability of different economic groups to push for higher incomes.

In a demand inflation, for example, there may be an initial fall in the level of unemployment and an initial rise in the rate of profit. Inflation then accelerates as labor achieves large wage increases that lead, in turn, to higher prices. In a cost inflation unemployment tends to increase.

This reduces subsequent cost pushes until the inflation comes to an eventual halt. Lags influence strongly the character of inflationary movements. Without them, an inflation would run its course almost instantaneously. Their existence is largely responsible for the manageable rates of inflation in most Western nations since Perhaps the most important lag is the wage lag, which results from the fact that collective bargaining is seldom initiated more frequently than once a year and that negotiations may drag on for weeks or months.

The process is also slowed by the fact that some months usually elapse before price changes are reflected in published index numbers. The wage lag is usually even greater for the so-called passive, or fixed income, groups. The greater the size of these elements, with their frequently anti-inflationary political views, the slower and smaller the rise in prices.

Inflation vs Deflation and Why It Matters

In industries that administer prices on the basis of cost changes, the lag between cost and price changes is probably less than the lag of wage rates behind changes in the cost of living. On the other hand, such prices may be insensitive to demand changes in a demand inflation.

In the public sector, there are lags in both receipts and expenditures. Increases in tax receipts, induced by inflation, are not received immediately in the Treasury.

Government expenditures often lag behind appropriations. These public-sector lags are probably the principal exceptions to our generalization that long lags mean slow inflations and vice versa. Escalated increases in income are no different in principle from wage increases or farm prices negotiated directly.

When escalated wage increases, for example, are no greater than warranted by the excess demand for labor, they can be considered on a par with wage increases on the open market. When wages are forced up by escalation, despite deficient demand for labor, the results are analogous to a cost push. In general, when escalated increases substitute for increases that would otherwise have been attained through other means, the institutional arrangements of escalation cannot be considered to have contributed to the inflationary process.

The impact of escalation will depend, in addition, upon the rate and frequency of adjustment as well as the percentage of population covered. If the total income-earning population were covered, with incomes escalated both immediately and proportionately to changes in a cost-of-living index, a crucial stabilizing lag would be eliminated from the system.

Typically, these conditions are not met in full and the lag is preserved in part. Statistical studies summarized by Franklyn D. Holzman suggest, surprisingly enough, that formal wage escalation has had no discernible influence on the speed of inflation in the United States, Great Britainor Denmark. The results suggest that escalation in these countries has served primarily as a substitute for, rather than an addition to, other income increases and that its extent has been determined largely by market forces.

It is well known that expectations play a major role in accelerating in flation, once price increases are already rapid. Hyperinflations, in particular, are characterized by a so-called flight from cash, which Cagan explains statistically as a consequence of an index of expected price changes.

In less rapid inflations, however, the public seems willing to pay a high price for the convenience of holding its customary stock of cash balances.

In the first place, people differ in their perceptions of past price trends, so that in creeping inflations not everyone realizes what has gone on. In the second place, recognition that prices have risen need not lead to anticipations of future increases. In the third place, even expectations of future increases do not necessarily lead to an acceleration of purchases.

In the United States, high and rising prices in both and led to a drop, rather than a rise, in expenditures for a wide range of consumer durable items. As long as people are willing to hold cash balances at a sacrifice of real income, continuous inflationary shifts in demand from money to goods require an increasing certainty about the upward price trend or an increase in the supply of cash or credit, or more usually both, as in the hyperinflationary cases.

Redistributive effects of inflation Inflation alters the distributions of both income and wealth, partly in a random and partly in a systematic manner. Prices of different goods and services, different productive resources, and different monetary assets, real assets, and liabilities are not equally flexible and respond differently to inflationary pressure.

Inflation & Deflation - : Definition, Causes, Effects, Basics

Furthermore, when inflation and deflation change the real value of cash balances, supply and demand functions for other goods and services change in different degrees, depending on their complementarities with cash balance holdings. Purely monetary assets and liabilities cash, insurance policies, bonds are completely inflexible unless escalated. Their nominal market values are independent of price level changes. Most monetary rent and interest incomes in America and western Europe are fixed contractually for long periods and so react slowly to price increases.

In underdeveloped countries, on the other hand, rent and interest obligations in kind are favorite inflation hedges. The values of physical assets held for use, rather than sale, adjust more or less proportionately to the price level.

Inflation & Deflation – Definition, Causes, Effects, Basics

Most other prices move with the price level but at different rates. The prices of durables tend to rise faster than the price of food; the wages of government workers and professionals usually lag behind those of industrial workers; and common stock and real estate prices usually overadjust to changes in commodity price levels. For this reason, these assets are often used as inflation hedges, along with precious metals, jewelry, art objects, and stable foreign currencies, whose prices have also shown overadjusting tendencies.

Assessment of the redistributive impact of inflation requires consideration of the relative impact on individuals and sectors of all these elements of inflation sensitivity. It is also difficult to separate the effects of general price movements on relative prices from the effects of other changes, including general economic growth.

In general, the differential impact of inflation on individuals and groups is a function of two factors: If everyone had equal abilities along these lines, inflation and deflation would have little or no redistributive effects.

There are, in fact, great differences on both accounts. It should also be remembered, on the other hand, that the larger the number of people who anticipate price changes correctly and adjust to them promptly, the more rapid the changes are likely to be. Two related hypotheses on the redistributive effects of inflation on income have been accepted for many years but have only recently been analyzed with care.

The first of these hypotheses is that in inflation money wages lag behind prices, so that there is a shift away from wages and in favor of profits. The second hypothesis states that business firms gain through inflation at the expense of households and public bodies, and vice versa for deflation. The wage-lag hypothesis has been argued in a number of historical studies.

Hamilton used it as an explanation of the financing of western European industrialization following the discovery of Mexican and Peruvian gold and silver deposits. Their conclusions have, however, been challenged, particularly by Armen Al-chian and Reuben Kessel These and other critics ascribe the orthodox results to an arbitrary choice of beginning and ending years and to other factors, such as population growth and migration to the cities, that would have presumably caused wage lags regardless of the course of general prices.

Alchian and Kessel conclude their study by considering the United States after World War II, when labor organization had achieved substantial strength.

  • Inflation vs Deflation and Why It Matters
  • Inflation and Deflation

They argue that, if the wage-lag hypothesis is valid, firms with large annual wage bills relative to equity would show proportionately higher profit increases. The opposite seems to have been in fact the case.

Several American studies have examined the changes in the functional distribution of income sincein attempts to test the wage-lag hypothesis more aggregatively. With regard to wages and profits, the picture is mixed. Some periods, such as toapparently conform to the wage-lag hypothesis whereas others, such as to and todo not.

relationship between inflation and deflation economy

Phelps has suggested that a demand inflation conforms to the hypothesis more closely than does a cost inflation. The studies of labor share, moreover, include both the effects of wage-rate changes and the effects of changes in factor proportions—as capital is or is not substituted for labor, as technical improvements occur, and as wage rates rise.

Levinson approached this by dividing the private economy of the United States into two sectors, one in which trade unions are strong manufacturing, mining, transportation, and utilities and one in which they are weak commerce, finance, trade, services, and agriculture.

The other conclusion—that business, or the corporate sector, gains through inflation and loses through deflation—involves two assumptions. If it is true that wages lag behind prices, it would follow that corporate profits tend to rise during inflations. A more common assumption, associated with both Fisher and Keynes, asserts that business is a net debtor and gains during inflation by the opportunity to pay debts in cheaper money.

A corollary is theproposition that banks, being particularly large debtors with an unusually large ratio of debt to equityshould gain disproportionately in inflation. This does not seem to be the case, perhaps because bank investments are concentrated in fixed money claims.

The several studies by Alchian and Kessel confirm the Keynes-Fisher assertion of the importance of the debtor-creditor status in inflation.

They take issue, however, with the assertion that business firms are net debtors. This assumption was true before World War i in the United States, but the Alchian-Kessel samples for the period after World War II found business firms distributed evenly between net debtors and net creditors.

relationship between inflation and deflation economy

The stock prices of debtor companies rose by larger percentages than those of creditor companies, but even this aspect of conventional wisdom was questioned in another study, by G. Bach and Albert Andocovering the period to Bach and Ando found the debtor-creditor position often overbalanced by the effects of a number of other factors, most importantly the volume of sales.

Turning from income to wealth, Bach and Ando studied the redistributive effect of inflation in terms largely of the net monetary fixed price asset or liability positions of different population groups. The aggregative figures show that in the United States over the decade to the household sector became a large net creditor and the government sector a large net debtor. Unincorporated business, nonfinancial corporations, and financial corporations were all nearly neutral.

More revealing was the percentage of net assets held in monetary form by income groups classified by income size. Except for the lowest income group, this percentage was approximately constant at from 13 per cent to 15 per cent of total assets. Calculations suggest that, as compared with personal income taxes particularly, losses on net monetary account from inflation are regressive.

The real locus of the burden of holding monetary assets in inflation is revealed by making similar calculations for different occupational and age groups. By far the highest concentration of monetary assets is found among the retired. High proportions are also indicated for professional and semiprofessional workers and for unskilled workers.

relationship between inflation and deflation economy

Farm operators and managers, on the other hand, suffer only minimally. The high figure for retired people is emphasized by the age-group breakdown, which records a higher proportion of monetary assets in the oldest age group 55 years old and over than in any other.

Finally, renters tend to lose relatively to homeowners when prices are rising. Since most members of the lower income groups cannot afford their own homes, this aspect of the cost of inflation weighs most heavily upon them. Review of Economics and Statistics Biacabe, Pierre Analyses contemporaines de Vin-flation.

Bronfenbrenner, Martin; and Holzman, Franklyn D. American Economic Review Conference on Inflation, Helsing0r, Denmark, Inflation: Edited by Douglas Hague. De Podwin, Horace J. Journal of Political Economy Pages in Stabilization Policies: Journal of Economic History 12, no. Pages in Measurement in Economics: Pages in Inflation, Growth and Employment: A Radical Plan for the Chancellor of the Exchequer. Here are a few ways you can retire financially sound keeping inflation in mind.

Inflation and Deflation in Hindi -- Macroeconomics-- To The Point -- by Lokendra Mishra

Invest in long-term investments. When it comes to long-term investments, spending money now can allow you to benefit from inflation in the future. Save More Retirement requires more money than one might imagine. The two ways to meet retirement goals are to save more or invest aggressively.

Difference Between Inflation and Deflation

Make balanced investments Though investing in bonds alone feel safer, invest in multiple portfolios. Do not put all your eggs in one basket to outpace inflation. Deflation will take place naturally, if and when the money supply of an economy is limited.

Deflation in an economy indicates deteriorating conditions. Deflation is normally linked with significant unemployment and low productivity levels of good and services. Deflation can be caused by multiple factors: Structural changes in capital markets When different companies selling similar goods or services compete, there is a tendency to lower prices to have an edge over the competition. Increased productivity Innovation and technology enable increased production efficiency which leads to lower prices of goods and services.

Some innovations affect the productivity of certain industries and impact the entire economy. Decrease in supply of currency The decrease in the supply of currency will decrease the prices of goods and services to make it affordable to people.

Effects of Deflation Deflation may have the following impacts on an economy: Reduction in Business Revenues In an economy faced with deflation, businesses must drastically reduce the prices of their products or services to stay profitable.

As reducing in prices take place, revenues begin to drop.