!-- End Google Tag Manager (noscript) -->

Differences between inflation and deflation

2 min. reading
Financial Education / 6 May, 2020

María Arroyo Third party products

Due to the current crisis situation we are living, we are often seeing in the media the terms “inflation” and “deflation”. Both terms can be confusing on occasions, so here we provide a brief and simple overview to give you a basic idea of the two concepts.

Inflation

Inflation is the increase in the price of goods and services. This increase has two main characteristics:

  1. It is sustained, which means that it is not seasonal, the tendency will be for it to remain over time.
  2. It is widespread, affecting most of the sectors that make up the economy.

The increase in prices may have different causes, which means we have different types of inflation. Below we look at the most significant:

  • Demand-pull inflation: Occurs when the demand for goods and services rises and producers cannot meet this increase
  • Built-in inflation: occurs when people anticipate an increase in future prices and immediately build it into their expectations to try and reduce the future effect of this price increase
  • Cost-push inflation: occurs when the price of raw materials becomes more expensive, in this case, the producer will need to increase prices to maintain their profit level, which will lead to an increase in prices
  • Monetary inflation: occurs when central banks increase the level of money supply above the increase in the supply of goods

Now, after reviewing the basic concepts of inflation, we consider, what are the effects of an excessively inflationary environment?

The main consequences would be:

  • Loss of purchasing power: with goods and services more expensive, the consumer can buy fewer of them since more and more money is needed to buy the same number of products
  • A brake on business productivity
  • Uncertainty about the future
  • Inefficient allocation of resources

Deflation

Also called negative inflation. During a deflationary period, prices fall in the same way as they arise in the case of inflation: continuously and in a generalised manner.

This fall in the prices of goods and services may have different causes, in this case, they would be:

  1. Insufficient demand: normally occurs in economic recessions or depressions, in which consumers have less spending capacity, so they demand far fewer goods or services
  2. Excess supply: in this case producers are forced to reduce prices, in order to sell their output and not suffer an increase in inventories

At a theoretical level, other consequences of deflation are:

  • The danger of a vicious circle: fall in demand – decrease in prices- fall in profits – cost reductions – job cuts – fall in demand
  • Reduction in economic activity
  • Increase in unemployment
  • Uncertainty

Whatever the situation and outlook, we can find investment opportunities to match your risk profile. The BBVA team in Switzerland is available to help you with whatever you need.

Related news