Inflation and deflation affect the relative price level and aggregate expenditure. They cause substantial damage to the state economy and worsen overall social situation. Both processes define characteristic changes such as distribution of income between economic classes and total output. Neither inflation nor deflation means that all prices move in one direction or change in the same proportion. While inflation brings benefits to debtors and recipients of profits at the expense of creditors and recipients of fixed incomes, deflation has the opposite effect. This paper aims to analyze the issues of inflation and deflation and their effects on economy.
The Role of Inflation and Deflation in the Economy
Financial executives face business risks because the economy constantly experiences recession and recovery. Therefore, they should be well aware of the fact whether their business experience rising or falling prices. In most cases, they should monitor potential effects of inflation or deflation on their operations. As a rule, their purpose is to make wise solutions that can prevent them from business risks. Many experts consider inflation as the primary threat that can destroy or undermine economic growth.
Inflation is the greatest fear for global bankers, enforcing them to implement unpopular monetary policies. It impoverishes a large percentage of populations, making others unfairly rich. Inflationary and deflationary processes predetermine the change in the purchasing power of money.
Under certain conditions, inflation is quite normal economic process during which the general rise in the price level comprises not more than 5 percent annually. However, deflation can be a harbinger of a crisis, accompanied by serious unemployment. It can simultaneously manifest itself in various fields. Historically, inflation could destroy the entire economies such as the Roman Empire or the Soviet Union. The money market analysis indicates that inflation is usually caused by excess of money supply, while deflation is caused by a lack of money in circulation. Consequently, both processes are caused by the influence of the same factors but at a different orientation of their manifestation. Therefore, it is important to control inflation or deflation because they can worsen overall social situation.
Despite the influence of the common factors in the history of the world economy, it is much more likely to be exposed to inflation than deflation. Their regulation is of a great importance to ensure the stability of the national currency in order to maintain overall macroeconomic stability. The function of regulation is mostly performed by the state. According to the research, the absence of inflation and deflation means the stability of the pricing process and the formation of monetary savings and investment projects. The interconnectedness of the factors of inflation and deflation, symmetrical consequences of these processes, and their impact on the purchasing power of money leads to a conclusion that inflation and deflation are equal functional parts of an economic system.
Inflation, Its Causes and Consequences for Economy
The concept of inflation has a very generic meaning and it does not have a commonly accepted definition. Moreover, there is no common opinion what constitutes its levels (e.g. inflation, high inflation, and hyperinflation). Typically, inflation means a general increase in prices represented by a Price Index such as Consumer Price Index. Usually, all prices rise simultaneously in the price environment. The term “inflation rate” is introduced to express the annual growth in prices, and if it is around four percent during the last three months, this economic state is characterized as inflation.
Inflation is usually caused by an imbalance between the expansion of the economy and the increase in the money supply. Therefore, if money supply increases faster than economy grows, it often leads to high inflation. It can also be caused by an imbalance between supply and demand for commodities. If there is a high demand for a limited number of goods, its price rises, and this can lead to inflation. The literature reveals that a more rapid increase in the quantity of money than in output becomes a major cause of inflation.
The main socio-economic effects of inflation include the decline of real incomes, uneven rise in prices, redistribution of national income between the layers of the population, a generation of additional revenue, extracted mainly from the private sector, the rise of the uncertainty, and risk of conducting any economic activity. On the other hand, a moderate inflation creates incentives for domestic economic growth. However, hyperinflation generates socio-political problems that undermine the political stability of the society and increase social tensions.
Deflation, Its Causes, and Consequences for Economy
Deflation is a reverse process of inflation, meaning a decrease in the general price level in economy. The main cause of deflation is an insufficient amount of cash in circulation. Consequently, during deflation, the purchasing power of the national currency rises. It results in the slowdown of domestic consumption due to reduced demand. Consequently, consumers are reluctant to buy goods and services, hoping to reduce their prices in the long term. The financial sector slows down because loans become more expensive. Moreover, it becomes harder to maintain the external debt because loans’ real cost increases. Despite the fact that store prices for the goods begin to decline, uncontrollable deflation is no less dangerous than inflation.
Deflation can be caused by a wide variety of factors such as increase in the value of money; labor productivity growth, causing reduction in the cost of products and services; insufficient financial weight on the market; and the refusal of the population to spend their earnings in anticipation of further increase of money value. As a rule, deflation means a general decline in the price level that has typically random and negative character. In some cases, deflation occurs due to the artificial withdrawal of excess money from circulation, initiated by the government meaning to reduce inflation by increasing taxes, strengthening foreign exchange and trade.
In most cases, deflation leads to a number of unpleasant consequences. During deflation, investors stop investing in the production of goods, as everyone wants to buy at the lowest prices. At the same time, production sector begins to experience the deficit of cash. This leads to a reduction in employees’ salaries and production volumes, as well as decreased profitability of companies. As a result, reduced production provokes unemployment. Moreover, the fall of profits may exacerbate social tensions.Thus, inflation and deflation are processes that can cause quite serious instability in state economy. That is why even the slightest changes in prices upwards or downwards should be monitored by the state in order to avoid the impact of such processes on the viability of populations and functioning of domestic enterprises, supporting domestic market at a stable level. Although inflation comes in useful to debtors and recipients of profits at the expense of creditors and recipients of fixed incomes, deflation constitutes the opposite effect. Every state tries to control inflation and deflation, as both processes when out of control can cause substantial damage to the national economy and aggravate the social situation.
About the author: Alice Grey is a bachelor in English philology and sociology at California University. She is currently working as one of the best writers at the essay online store She also studies feminine psychology.
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