Macroeconomics - Inflation, Disinflation and Deflation - Term Paper Example

The report has been prepared in order to build a thorough understanding of the three important and interrelated macroeconomic concepts, i.e. inflation, disinflation, and deflation. The report will determine the causes of each of the concepts in an economic environment and several repercussions they can make into the global financial system. The academic definitions of inflation, disinflation, and deflation will strengthen the reader’s understanding before providing the complex details of each of the concepts and applications. The final section has presented conclusions and recommendations to the economists in terms of how the inflation, disinflation, as well as deflation can be controlled. Introduction The global financial crisis has led the whole world to think of taking the radical measures through which the financial situation of the globe can be improved. The global recession spread across Europe and US has also caused everyone to become indebted. This situation serious attention and the first thing that the economists need to do are to review the macroeconomic policies in their respective economies in order to reform them. The most dangerous economic ailment that is also considered as a potential cause of economic recession is inflation, which is known as the sustained rise in the general level of prices for the goods and services. Due to the inflation, the monetary value liquidates and although people have same amount of money, but their buying power is reduced. Therefore, the purpose of the report is to make the readers understand some of the basic yet alarming principles of macroeconomics that are leading the current financial situation in to its worst era. Apart from the causes and effects of inflation, the disinflation, and deflation will also be discussed. In the end, the conclusions and recommendations will be made concerning how the inflation and its forms can be overcome. Inflation: Inflation is defined as a continued increment in the original level of the prices of all the goods and services that are part of the local or global economy. Inflation is generally measured in terms of the percentage increments on the annual scale. With the rise of inflation, the purchasing power of the consumers lowers as the worth of a dollar or a euro is decreased and eventually the buyer will purchase the smaller percentage of a service or a good with the same amount of money that formerly offered relatively more purchasing power. The value of the dollar keeps changing or increasing with the consistent rise in the inflation. As mentioned above, the value of a currency will be measured in terms of the purchasing power, i.e. what purchasing one can do with that currency. The purchasing power is normally considered in terms of purchasing only the tangible goods that are real and can actually be bought with money. When there is a rise in the inflation, the purchasing power of the money will decline. A classical example of the inflation would be as follows: suppose there is an inflation of 2% on annual scale. The rise in the price of a good that had the price of $1 before will now be tagged as worth $1.02. After the inflation has increased, the same amount of currency can never buy the same quantity of goods that it used to buy before. Different causes of inflation are reported in the modern macroeconomics. With every day that passes, the economists aspire themselves to expect from them to debate the causes of inflation, but these are not that easy to be discussed, as there are many hidden ways through which inflation rise, which is in economic terms called an invisible hand, that lets the market operate freely but causes many fears such as that of inflation. There are basically two theories that can actually define the real causes of inflation, and which are agreed upon by the economists all over the world to be correct approaches. First theory is demand-pull inflation, according to which if the demand of a certain product or service is increasing rapidly, and supply is not that enough to meet the consumer demands, then the prices will increase. Most of the growing and emerging economies have these kind of issues due to which the inflation rates are much higher in emerging economies. Second theory is about the cost-push inflation, according to which when the production costs of the manufacturing companies go up, then the price is increased so that the companies maintain their own profit margins just as same as they were before. This rise in price will result in inflation. The costs that have increased can be termed as the wages, taxes, or the enhanced imports costs. The inflation affects different people in many different ways, and to think inflation is an evil is not the right thing to say. If the inflation rate rise is something that majority of the people are expecting to happen, then the inflation rates can be compensated and the prices of goods do not go very high. This is called as anticipated inflation. The second type is the unanticipated inflation according to which people do not really expect a rise in the inflation and if such an unexpected inflation has occurred, then serious repercussions are bore by the economy. Disinflation: To fully understand disinflation, it’s imperative for one understand the concept of inflation, which has been discussed before. The concept of disinflation is more trickier than the inflation because the word inflation itself is used actually in two different contexts. Inflation means the rise in the prices, where consumers have to pay more for the same goods or services for which they were paying a lesser amount before. However, there is another meaning of inflation, which means the increase in the money supply, as in that case only, the consumers will have the lesser value of a currency because of the more monetary capital in the market, and that will mean that the same quantity of goods will be purchased but the more amount of money available in the market will be used for purchasing. This second concept is actually knows as the monetary inflation. Inflation is commonly measured through an index and that is known as consumer price index, and the percentage change in the CPI will calculate the inflation rate for a year. Coming to the point, from where did the concept of disinflation originate. Disinflation will refer to a situation in which the consumers are experiencing a price increase in the goods and services, but that price increase is not being made at the same rate as it was done before. Rather rise of price will actually slow down. An example of the disinflation will be as follows: Suppose that the inflation rate is 5% in Month A. in the following month B, the inflation goes down to 4%, where the inflation rise is for the previous 12 months for month A as well as for B. In this case, the 1% disinflation will be experienced. Many people confuse the disinflation with the deflation, because many think that disinflation is also another opposite of the inflation, which is wrong, as disinflation also predicts a rise in the prices but the rising percentage is lower than the one that was experienced before. But disinflation will not mean that the price is decreasing, because in that case the inflation will be in negative terms, such -4%, but in the above example it was 4% which means it was positive, and that will imply disinflation to be happening. The largest difference between disinflation and deflation in terms of the prices of the goods and services is that the prices start falling down in case of the deflation, whereas the prices remain the same, and neither they go up nor go down in the case of the disinflation. Deflation: Deflation is generally termed as a continued decrease in the prices of the goods and services consumers buy. In classical economics, deflation is terms as the absolute opposite of inflation, but there is more to be added than just saying it’s the opposite of inflation. Therefore, the classical definition of the deflation as it was used in the Great Depression is: a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. There are numerous causes of deflation to be discussed. A true understanding of both the inflation as well as deflation will require the understanding of the principles of market supply and market demand. As we use goods and services by buying them through money, in the same way, money is also bought so the principles of demand and supply also apply on money. For a specific good or service, its different prices levels will actually set the relationship between the supply and demand of this particular good or service. On the other hand, the value of money, which is going to be used to buy that good, is also subjected to the same relationship of supply and demand. Assuming that there are ten people on earth, and there are ten goods available in the world which have the same $1 bill each, and on the basis of which we can make this an assumption that each of the good will cost $1. Now when the quantity of money increases and goes up to $20, and the quantity of the goods is kept the same, the price of each of the goods will increase to $2 – which is inflation. In other case, where the quantity of goods remains same as 10, but the quantity of money goes down to $5, then the price of each good will decrease to 50cents – which is deflation. So the main cause of deflation has been known to be the reduction of money from the market, as in that case, quantity of goods will remain same but the money in the financial institutions will fall down, resulting in the increase of the purchasing power which will give rise to the consistent fall on supply and increase in demand. Conclusion: I have worked on a report that is about the discussion of the three main concepts of macroeconomics, i.e. inflation, deflation, and disinflation. The studies that have been incorporated throughout the report will show that these three concepts are absolutely connected and related to each other. Inflation has its opposite in the form of deflation, whereas disinflation is considered as the mini inflation. From all these concepts, the inflation is the main macroeconomic principle where as the other two; deflation and disinflation are the derivatives of inflation. The main conclusion from the study is that inflation and deflation are the two driving forces that drag the prices sometimes up and sometimes down. The rise in the inflation leads to rise in supply and decline in demand, where as the deflation rise will result in the decline in supply and rise in demand, and this cycle goes the same way. The main recommendation for the economists would be that they must support the macroeconomic policy in which deflationary measures are taken so that the prices of the goods and services go down and the common consumers could lead a life by facilitating himself with enough resources. References: Shilling, A. Gary. Deflation: How to Survive and Thrive in the Coming Wave of Deflation. New York: McGraw-Hill, 1999. Print. Flemming, John Stanton. Inflation. London: Oxford UP, 1976. Print. Disinflation West European Experiences ; 2nd Colloquium of the Confederation of European Economic Associations ; Frankfurt, FRG, May 9-12, 1984. Berlin [u.a.: Duncker & Humblot, 1985. Print. Barro, Robert J. Macroeconomics: a Modern Approach. Mason, OH: Thomson South-Western, 2008. Print. Frank, Robert H., Ben Bernanke, and Louis Johnston. Principles of Economics. Boston: McGraw-Hill/Irwin, 2009. Print. Read More