Inflation vs. Deflation - Why Both Can Be Dangerous for an Economy

Although inflation and deflation are complete theoretical opposites, they can both cause real damage if things aren't situations aren't taken care of. When prices rise exponentially, a currency's buying power power plummets. That is the effect of inflation. Deflation occurs when prices decrease because people and businesses are spending less. Countries do just as bad with deflation, as this can cause less production, spending, and economic slow-down.

 

When inflation climbs too high, it acts like a silent tax. Each dollar buys less than before, and savings lose value. Moderate inflation is not bad, as it suggests that workers are getting paid more money because they are producing more goods. However, when it increases in speed more quickly than salaries do, people can't cope. Many businesses are unsure what will happen to their costs, investors are fleeing risky assets, and policymakers are stepping in.

 

A striking instance is that of the United States in the 1970s. OPEC oil embargoes hiked energy prices. This was to blame for inflation which eventually topped 13% in 1979. The price of regular goods became costlier by the month. Wages couldn’t keep up with it. Interest rates rose to a higher level. During the early 1980s, the Federal Reserve, led by Paul Volcker, raised rates above 20%, which caused a deep recession but managed to crush inflation. This event taught us that allowing inflation to run too high results in painful corrections.

 

In the 2000s Zimbabwe had hyperinflation where inflation get to the trillions of percent a year, a more extreme case. The government created cash to meet its spending while the economy shrank. By the end of 2008, people were sensing the pinch, unable to afford basic things like bread, fuel, and daily essentials which were proclaimed too costly. People began using U.S. dollars and South African rand instead of the local currency, and the Zimbabwean dollar totally collapsed. When hyperinflation occurs, confidence in the currency of a country is lost. Any hopes of an economic recovery can take years, perhaps decades.

 

The inflation rate in the United States has dropped small after pandemic times. In 2021-2022, inflation jumped above nine percent—the highest it has been in 40 years—due to supply chain bottle necks and stimulus spending. While this did not come anywhere close to Zimbabwe levels, it did show how quickly inflation can come back when supply can’t keep up. The Federal Reserve had to hike rates aggressively after gas prices, rent and groceries surged in order to bring inflation back down. Making sure that prices don’t go too high and that businesses still make money is not easy.

 

Deflation, on the other hand, sounds appealing at first. Who wouldn’t want prices to fall? However, when prices fall too far, people will stop spending and businesses stop investing because they think prices will be lower tomorrow. Paraphrase Stop avoiding a recession: don’t panic, stop spending, and start increasing prices (15 words)

 

The Great Depression of the 1930s is the classic example. Between 1929 and 1933 prices in the United States dropped by approximately 25%. Factories closed, unemployment reached 25%, and low-wage workers were paid less. As it became more difficult to pay back debts — because the dollars used to repay them cost more than before — defaults increased. Furthermore, banks began failing too. The economy of the United States was in a serious downturn long before the events of October 1929. The U.S. economy recovered from its slump with tons of government intervention money, including the New Deal and then World War II spending.

 

Another example of a long-lasting deflation episode is Japan’s “Lost Decades” following the collapse of its asset bubble in 1990. Japan grappled for years with stagnant prices, weak consumer demand, and low growth. Companies held back on investment. Wages remained flat. Interest rates stayed close to zero. Although Japan’s deflation wasn’t as severe as the 1930s, it still shows how hard it can be to get a economy back on track when falling prices becomes the norm. The government and central bank of Japan tried huge infrastructure projects and aggressive monetary policies. However, the psychological side of deflation which means expecting prices to not change or drop always held the economy back.

 

Inflation and deflation may influence government’s debt too. With inflation, it is easier to pay back debts as the money that you owe becomes worth less and less. That may attract governments to allow higher inflation that will lessen debt. When deflation occurs the value of debts increases in real terms. Debts become more expensive for households, companies and governments. That’s the Reason U.S., Central Banks Do It Central banks, like the Federal Reserve or the European Central Bank, want to hit an average inflation over 2% per year. This level is high enough to keep the economy moving, but low enough so as not to compromise the value of money.

 

Over time, it isn’t just inflation or deflation alone that might pose a serious risk, but what authorities do in response. Raise interest rates too slowly, and inflation can spiral. If you tighten too much, you can cause deflation or a recession. Today’s global economy is between two risks. After years of low inflation, the central banks are faced with new dilemma– this time to tame the prices while not slowing down the growth too much.

 

Ordinary people feel both inflation and deflation are cruel, just in different ways. Prices going up is not the same as prices coming down. Deflation can make life uncertain; inflation can make life expensive. Through history, when prices become unhinged things tend to fall apart in the economy. This means price stability is important; hence, the economist’s doctor often prescribes it to the economy.

 

The 1970s and 1930s teach us that small and steady inflation is the best, the sweet spot. Too much heat, and the economy burns out. Too little, and it freezes up. Keeping balance while implementing economic policy is a challenge in itself and it is also one of the most vital tasks to achieve stability for a period of time.