Inflation and Deflation are the fundamentals of economic and personal Finance. It occurs when the price of goods and services rise, while deflation occurs when those prices decrease.
For any economy, the rise in price is good than the fall in price. These two factors have a huge influence on personal financial planning. This article will deal with the merits, demerits of both Inflation and Deflation and their role in personal finance.
By the end of this article, as an individual, you will understand the advantages of both parameters and take leverage of your personal wealth.
Let us understand to focus on a deal with these both definitions.
Inflation:
It is a measure of how quickly the price of goods in an economy is increasing. Inflation is caused when goods and services are in high demand, thus creating a drop-in availability.
A healthy inflation rate (2-3%) is considered positive because it directly results in increasing wages and corporate profitability and maintains capital flowing in a growing economy.
Deflation:
Deflation occurs when too many goods are available or when there is not enough money circulating to purchase these goods. As a result, the price of goods and services drops.
Types of Inflation and Deflation:
There are almost 6 types of Inflation and only one type under Deflation. Actually, Deflation is a part of Inflation. Here are the following types,
- Creeping Inflation – This is when the price of goods rises up to 3% or less in a year.
- Walking Inflation – This is termed to be destructive inflation. 3-10% growth on price level is classified as Walking Inflation.
- Galloping Inflation – A strong form of Inflation, where the price of goods rises more than 10%. Literally, demand for goods starts declining in a greater percentage.
- Hyperinflation – The time when demand falls to earth and price move to the sky is the beginning of Hyperinflation. The period when the price skyrocket to 50% or more. During this period, there will be a huge job loss.
- Wage Inflation – Wage inflation is when employers pay their employees higher than the normal inflation rate over the nation.
- Stagflation – The period when inflation of price climbs higher while the economic growth of a nation is stagnant. This is a big contradiction in economics.
- Deflation – This usually happens when an asset bubble bursts. The real estate industry is one fine example of deflation. The price starts declining at greater rates. Deflation is more dangerous for any country or investor.
Causes and Effects of Inflation and Deflation:
Causes of Inflation:
Once we have understood the types, let’s beam towards the major reasons behind these economical factors. They are Money Supply, National Debt Burden, Demand-Pull Inflation, Cost-Push Inflation, and exchange rates.
Money Supply:
The money supply is always termed under the banner of excess money is printed and circulated in the system. Whenever a country faces a shortage of currency to run the economics, RBI prints the money to manage the situation. The Excess cash printed will be the main reason for Inflation.
We live in the era of Fiat Currencies, here people use to calculate the value of any currency against the amount of Gold they hold. At present, the theory became an old story. The amount of currency a nation holds is completely irrespective of the amount of Gold it has. This makes an economical imbalance among people by the term Inflation.
The debt of the Country:
The second main reason that causes inflation is Nation’s Debt. It might be due to various factors influencing the increase in debt.
- High Borrowing from Developed Countries
- High Borrowing from Reserve/Federal Banks of the Nation
- Low Turn over in returns.
The basic solution every country take by their hands are,
- Increasing the Tax Rates
- Slipping the Interest Rates of Government Saving Plans
- Printing a Huge amount to reduce Debt. This will obviously pull up the inflation.
Demand-Pull Inflation:
The demand-pull is termed as inflation caused by increasing demand. In an economy, as the wages keep increasing, the cost of manufacture/supplies increases. This generates a huge demand for services and goods, as the result, the pricing increases drastically. This will make a balance in the demand and supply.
Cost-Push Inflation:
The period when a company faces an increase in the charges of raw materials. As the raw materials charges increase, they will be in a situation to push the cost of the production and product to the customer. This puts up inflation to the public of the country.
Causes of Deflation:
The significant reasons for deflation can be increased competition, Increased Production, and a Decrease in Printing Currency.
Increase in Competition:
The essential factor for deflation is an increase in competition for any product. This makes more supply into the market than demand. As a result, the price of every good has to slip down to adjust the supply vs. demand.
Increased Production:
This case is the same as the previous cause. But, the difference is the increase in competition, and here the reason is increased production. So, increased production will spunk the cost of goods and services. This put the economy under a situation of deflation.
Decrease in Printing Currency:
When the currency is less printed in any economic duration, it will also be a sign of deflation. So, it is not necessary for a country should print money. But, less currency or NIL currency printed will lower Inflation rates.
Effects of inflation:
- Inflation always makes demand to shutdown in the market, when its rate spikes unconditional.
- When the cost of goods and services rises, people don’t consume more products.
- This brings fatigue to the production setup. As production decreases, the need for workforce also eventually come down
- This brings Job cuts in all MSME, small-scale industries, and even corporates.
- The Job Cut further involves a decrease in the consumption of products, and it forms a destructive cycle to the economy.
Effects of deflation
- Deflation is more dangerous than Inflation for any economic condition.
- This lowers the economic activity of a country, as there is no proper growth in pricing is seen.
- Deflation also increases the rate of unemployment.
- Deflation might lead to a lowering of business profits. This will seriously put a zero growth in wages.
Conclusion:
- Both Inflation and Deflation are parts of the economic condition of every country.
- Inflation is better than deflation. But the rate of inflation is what has an influence on good or bad. A rate of 1-3% inflation is always termed as an Ideal one.
- As an investor, we should focus on protecting our investments. The only way to preserve the investments amidst inflation is only by Long Term Investing.
- At the same time, Inflation has a huge role in benefiting your retirement planning while invested in proper assets.
- A proper Asset Allocation strategy will also help to preserve your investments irrespective of inflation and deflation.