Inflation and
Deflation:
Causes, Types,
Consequences,
and Control
Policies
Here is where our presentation begins
OBJECTIVES
In this presentation you would understand and know;
● definition of inflation and deflation
● Causes and types of inflation and deflation
● Consequences and effects of both inflation and deflation.
● Know the effective policies available in order to control and
counter both inflation and deflation
● Describe the measures of both inflation and deflation and
describe the possible policy conflicts between inflation and
deflation
03
01 measureme
inflation nts
Definition, causes, To measure the rise
types, consequences and falls
or effects , policies
available to control
inflation
04
02 possible
deflation conflicts
Definition, causes,
types, consequences Conflicts between
or effects , policies inflation and deflation
available to control
deflation
INTRODUCTION
Sheesh……no dirty
vibes!!!!!!!
The laws of economics are to be
compared with the laws of the tides,
rather than with the simple and
exact law of gravitation.
—alfred marshall fba
01.
inflati
on
Definition, causes, types,
consequences,beneficial
effects and effective
policies available to control
inflationion
Understanding inflation
Inflation
Inflation is referred to as the rise in
prices over time which affects the
economic health significantly.
A fall in the rate of inflation is
known as disinflation
Causes of inflation
02
01 Demand pull
Cost push inflation
inflation
Occurs when the price level is Occurs when the price level is pulled
pushed up by increases in the costs up by excess demand leading to an
of production. The initial rise in the increase in AD due to higher
price level is likely to cause consumption, investment,
workers to press for even higher expenditure or net exports
wages, leading to a wage-price
spiral 03
Built in
inflation
Driven by the expectation of future
inflation, causing businesses to
preemptively raise prices. This can
create a self-fulfilling cycle of price
1. Walking Inflation Types of inflation
● Definition: Moderate inflation that is above creeping levels, usually between
3% and 5%.
● Characteristics: Can influence consumer expectations and spending
behavior.
2. Creeping Inflation
● Definition: A slow and steady rise in prices, typically around 1% to 3% annually.
● Characteristics: Seen as manageable and often associated with economic growth
3. Galloping Inflation
● Definition: A rapid rise in prices, often exceeding 10% annually.
● Characteristics: Can lead to economic instability and loss of purchasing power.
4. Hyperinflation
● Definition: An extremely high and typically accelerating inflation rate, often
exceeding 50% per month.
● Characteristics: Can lead to a complete loss of confidence in the currency and
economic collapse.
Consequenc
es &
beneficial
effects of
inflation
THE HARMFUL EFFECTS OF INFLATION Consequences of inflation
[Link] causes a fall in the value of money:If prices are rising, each unit of
money (for example, each dollar) will buy fewer products. The higher the inflation rate,
the greater will be the fall in the purchasing power of money. In a situation of
hyperinflation, the value of money may be falling so rapidly that people may lose
confidence in using the country’s currency as money. 50% is usually taken to be the
minimum rate to qualify as Hyperinflation.
2. Inflation redistributes income in an unplanned way: Some people gain from
it, while others lose. Workers with strong bargaining power tend to gain, as their
income usually rises more than the inflation rate. Normally borrowers also benefit. If
the rate of interest is below the inflation rate, borrowers pay back less in real terms
than what they [Link] with low bargaining power and those with fixed
incomes also suffer during a period of inflation. The government can seek to protect
some vulnerable groups from inflation by index-linking state benefit payments and
interest rates on government securities
3.• The existence of inflation imposes extra costs on firms:Some additional
staff time
will be taken up, estimating future costs of raw material. There will also be menu and
shoe-leather [Link] if the firms plan to pay out the money relatively soon, for
example on wages or raw materials, it would need to protect its value by placing it in a
bank or other financial institution, which will pay a rate of interest above the inflation
cont.
4. Inflation creates uncertainty: It can make it hard for households and firms to
judge the right price to be paid for products now. It can also make it difficult to plan
ahead, as households and firms will be uncertain about future prices. This is a
particularly grave problem with a high, fluctuating inflation rate. In such an unstable
situation, firms may be discouraged from investing which will be harmful for the
economy.
5. Inflation can harm the country’s balance of payments position: If a
country’s inflation rate is above that of its rivals, its products will become less price
competitive. This may result in a fall in export revenue and a rise in import
expenditure. Such an effect would cause a deterioration in the current account
balance. The fall in demand for the country’s
products may also result in a rise in unemployment
6. Inflation can cause fiscal drag: This occurs when governments do not adjust tax
brackets in line with inflation. As a result, people’s incomes are dragged into higher tax
brackets and they are left with lower real disposable income.
The beneficial effects of
You might be surprised to learn that inflation can have beneficial effects also. inflation
These
effects are more likely to occur if the inflation is of a demand-pull, low and stable
nature and is below that of rival countries
• Inflation may encourage firms to expand. A low and stable level of demand-
pull inflation may make entrepreneurs optimistic about future sales.
• Inflation reduces the real burden of any debt that households and firms have
built up. This may mean that some households and firms will avoid going
bankrupt.
• Inflation can prevent some workers being made redundant in a declining
industry or region. This is because whilst workers are likely to resist any cut in
their money wages, they may accept their money wages rising by less than
inflation. In such a case, firms’ real wage costs will fall without resorting to a
retrenchment of worker
Policies
available to
control
inflation
Ways of controlling inflation
policies
Monetary Policy Adjustments
● Adjusting interest rates helps control the money supply,
influencing spending and saving behaviors.
Fiscal Policy Modifications
● Changing taxation and government spending can stimulate or
restrain economic activity to manage inflation.
Supply-Side Policies
● Improving production efficiency and reducing costs can enhance
supply, helping to stabilize prices.
deflation
Definition, causes, consequences &
beneficial effects, policies available to
control deflation
Deflation is
referred to as the
sustained fall in
the prices of
goods & services
Types of deflation
Good Bad
Deflation Deflation
Occurs from technological
Caused by decreased
advancements, reducing
costs and prices. For demand, leading to
example, innovations in
economic [Link]
manufacturing can lead to
cheaper production Example is a recession
where consumer spending
drops significantly.
Causes,consequen
ces & beneficial
effects
Causes
Technological Advancements
Innovations can lower production costs significantly, resulting in lower
prices for goods and services
Increase in Aggregate Supply
Overproduction can saturate markets, prompting price declines as
supply outstrips demand
Decrease in Aggregate Demand
A drop in consumer and business spending leads to reduced overall
demand, triggering deflation.
consequences
Increased Real Value of Debt
● As prices fall, the real value of existing debt rises, making
it harder for borrowers to repay loans.
Delayed Consumption
● Consumers may delay spending, anticipating lower prices
in the future, which can stifle economic growth.
Increased Unemployment
● Businesses facing reduced demand may cut jobs, leading
to higher unemployment rates and less consumer
spending.
1. Increased Purchasing Power
● Definition: As prices fall, consumers can buy more Beneficial effects of
with the same
amount of money. deflation
● Benefit: This can enhance the standard of living, particularly for those
on fixed incomes, as their purchasing power increases.
2. Lower Costs for Businesses
● Definition: Deflation can lead to lower costs for raw materials and
production.
● Benefit: Businesses may benefit from reduced operating expenses,
potentially leading to higher profit margins if they can maintain sales
volume.
3. Encouragement of Savings
● Definition: When prices are falling, the value of money increases over
time.
● Benefit: This can encourage consumers to save rather than spend,
which may lead to greater capital accumulation for investments in the
long run.
4. Incentive for Efficiency
● Definition: Businesses may strive to improve efficiency to maintain
profitability in a deflationary environment.
Policies available to
control deflation
Ways of controlling deflation
Quantitative Easing policies
● This policy involves increasing the money supply through central bank
actions to encourage lending and investment, fostering economic
activity.
Monetary Policy
● Lowering interest rates encourages borrowing, which can stimulate
spending and investment, helping to reverse deflationary pressures.
Fiscal Stimulus
● Increased government spending can directly boost demand for goods
and services, essential for combating deflation and promoting
economic growth.
Measurements
of inflation &
deflation
Measurements of inflation &
deflation
To measure rises and falls in the price level, governments construct price
indices (also referred to as price indexes). These show the change in
general price level in percentage terms over time. One of the main price
indices used is the consumer prices index (CPI)
CONSTRUCTING A PRICE INDEX
There are a number of stages in constructing a price index. These include
selecting a base year, finding out how households spend their
money, attaching weights to items of expenditure and then
finding out price changes from a range of trade outlets.
cont..
● Selecting a base year
Government statisticians try to select a relatively standard year in which there were no
dramatic changes, as a base year. The base year is then given a figure of 100 and the
price levels in other years are compared to this figure. For example, if the base year is
2015, it would mean that if the price index in 2018 was 123, the general price level
had risen by 23% between 2015 and 2018.
● Finding out how households spend their money
In calculating the average rise in prices, it is important to know how people spend their
money. This is because a price change in an item on which people spend a large
proportion of their total expenditure will have more impact on the cost of living than an
item on which they spend a relatively small proportion. Household spending patterns
are reviewed each year with new family expenditure surveys. If these reveal, for
example, that people are spending a greater percentage on recreation and culture, and
a lower percentage on food and non-alcoholic beverages, the weights of these items in
price index will be altered to reflect these changes.
● Finding out price changes
Each month government officials find out information about prices. E.g In the UK, about
130 000 price quotations are found for 650 different items. These are obtained from
shops, post offices, power companies, train companies and a range of other outlets.
From this information, the government estimates the change in prices.
Different impact of price
changes
A consumer prices index measures the price of goods and services
consumed by the average household. Of course, the expenditure of
particular households is likely to diff er from the average, in some way.
For example, families with young children will experience lower
inflation than other households, due to lower bills for healthcare and
no expenditure on university fees, if the price of healthcare and
university fees increase at a greater rate than the inflation rate.
Possible conflicts
Understanding the Challenges in Balancing Economic
Policies
● Some of the policy measures designed to reduce unemployment may
increase inflation. For example, an increase in government spending on
pensions would raise consumer expenditure. This rise would encourage
firms to expand their output and take on more workers. The higher
aggregate demand may, however, raise the price [Link] aimed at
controlling inflation may inadvertently lead to higher unemployment
rates, creating a trade-off that policymakers must navigate.
● Policy measures to reduce expenditure on imports may reduce
economic growth. A rise in
income tax, designed to reduce households’ expenditure on imports,
would also reduce
spending on domestically produced products. This fall in demand will
reduce the country’s
output or at least slow down the economic growth.
● Unemployment and economic growth both tend to benefit from
expansionary fiscal and
monetary policies. In contrast, contractionary fiscal and monetary
policies are more likely to be used to reduce inflation and expenditure
on imports.
THANK
S
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