Inflation and Deflation – Definitions
Inflation can be described as an upward increase in the average prices of goods and services (Satija 358). On the other hand, the term deflation refers to the phenomenon of falling of average prices of goods and services. In other words, deflation occurs when the prices of commodities fall and the value of money rises (Satija 357). It is worth-mentioning that price stability is the boundary between deflation and inflation (Satija 358). Both the mentioned phenomena are said to inflict extremely harmful impacts on the economic performance of a country as they affect the overall price stability. It can be said that neither inflation nor deflation helps in the economic growth of a country. Therefore, every country seeks price stability for the economic progression and advancement.
Inflation – Why is it a Problem?
Inflation in considered a grave problem by economists due to a number of disadvantages. To begin with, inflation creates an uncertain environment whereby the value of money and monetary assets erodes. As a consequence, investing, saving, and productive activity is discouraged (Satija 359). Second, inflation does not equally impact individuals ultimately causing unequal income redistribution. In addition, it also causes deterioration of balance of payments by stimulating import spending and dampening export profits. As inflation has a direct effect on costs, such state of affairs may lead to an increase in unemployment. Furthermore, inflation is also responsible for the distortion of the price mechanism
There are different types of inflation such as deflation, walking inflation, galloping inflation, hyperinflation, and stagflation (Pailwar 137). They are categorized on the basis of their speed and manifestation in an economy. The subcategories of inflation include core inflation, wage inflation, and asset inflation.
How is Inflation Rate Measured?
It is rather a complicated task for statisticians to measure inflation. However, there are two major methods through which an economy’s inflation rate can be calculated. Initially, several goods representing the respective economy are placed together as a market basket. Afterwards, a comparison of this basket’s cost is made over time. Consequently, a price index is obtained that signifies the current cost of the market basket as a % of the same basket’s cost in the preliminary year. Consumer Price Index (CPI) and Producer Price Index (PPI) are the two principal price indexes used for the measurement of inflation rate. As far as Consumer Price Index (CPI) is concerned, it is used for measuring price level changes of a market basket of goods/services that households purchase and consume. On the other hand, Producer Price Index (PPI) is a group of indexes used for the measurement of the changes in price levels at the wholesale level. In other words, price changes are measured from the seller’s point of view. PPI does not include exports as it only involves the measurement of domestic production costs (Marthinsen 88). It needs to be mentioned that there is a weak link between CPI and PPI as “the goods and services included in the CPI are only a fraction of the products included in the PPI” (Marthinsen 89).
Anticipated Inflation and Unanticipated Inflation
Anticipated inflation can be described as a predictable or known inflation that may not harm people as it is expected. As one can handle anticipated inflation through proper preplanning, it may not have a severe impact on consumers. For instance, if a household product’s price is expected to rise for any known reason, consumers may save that product in adequate quantities for the future use till the price stability is achieved. Anticipated inflation may be countered through proper usage of resources and appropriate future planning. In addition, people may also be able to foresee their business progress if inflation is anticipated. On the other hand, unanticipated can be best described as unexpected or unpredicted inflation. This type of inflation causes numerous problems for the respective populace. Money loses its value to a great extent. Such circumstances put lenders at great risk as their wealth is reallocated among to the borrowing individuals or groups. Due to the loss of money value, lenders lose and borrowers gain. Similarly, borrowers are the ultimate winners as inflation consumes the ostensible interest rates. In other words, whatever borrowers give back to the lenders does not have actual worth. In a similar fashion, unanticipated inflation benefits employers but brings disadvantages for the workforce. This is because employees are paid lower real wages putting them at the losing end. In addition, there is a substantial decrease in the purchasing power of the people due to the receiving of lower real wages.
In short, unanticipated inflation is far hazardous as compared to anticipated inflation. It can be proven by the fact that unanticipated inflation “cannot be incorporated in economic decisions” (Pailwar 153) and brings considerable changes along with it. In contrast, anticipated inflation does not bring much alteration in economic outcomes as it allows people to take preventative measures before its occurrence (Pailwar 152).
Marthinsen, John E. "Inflation, Real GDP, and Business Cyscles." Managing in a Global Economy: Demystifying International Macroeconomics. 2nd ed. Stanford, CT: Cengage Learning, 2014. Print.
Pailwar, V. K. "Inflation and Business Environment." Economic Environment of Business. 3rd ed. New Delhi: PHI Learning Pvt. Ltd., 2012. Print.
Satija, K. "Inflation." Textbook on Economics for Law Students. New Delhi: Universal Law Publishing Company, 2009. Print.