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Monday, 13 June 2011

The difference between deflation, disinflation and inflation

The difference between deflation, disinflation and inflation


Deflation is a sustained absolute decrease in the general price level resulting in a sustained increase in the real value of the monetary unit (money) and other monetary items.

The functional currency is the currency of the primary economic environment in which an entity operates. It is normally the national or regional currency or monetary unit and monetary unit of account in an economy or monetary union like the Rand in South Africa and the Euro in the European Monetary Union. In dollarized economies the functional currency is generally a relatively stable currency of another (generally the US) national or regional economy. The German Mark was also used in the past for the same purpose.

Deflation only happens below zero percent annual inflation. Deflation is not one or two months of month–on–month negative inflation during a twelve month period when it does not result in an absolute year–on–year decrease in the general price level. Deflation is the opposite of annual inflation. Deflation is negative annual inflation.

Money and other monetary items are worth more all the time during deflation as opposed to being worth less all the time during inflation. Inflation erodes the real value of money and other monetary items over time. Deflation creates more real value in money and other monetary items over time.

Disinflation is simply lower inflation. Disinflation is a decrease in the rate of inflation. Prices in an economy are still rising during disinflation, but at a slower rate. The general price level still rises, but, at a slower rate resulting in a continued, but, lower rate of real value erosion in money and other monetary items.

Disinflation is a lowering of the rate of increase in the general price level. A lowering of the absolute value of the general price level is deflation.

Deflation means the general price level is not increasing at all, but, actually decreasing continuously and money and other monetary items are worth more all the time. Deflation causes an increase in the real value of money and other monetary items.

Inflation erodes the real value of money. Disinflation erodes the real value of money at a slower rate. Deflation creates more real value in money.

Inflation is a sustained increase in the general price level. Disinflation is a slower sustained increase in the general price level. Deflation is a sustained decrease in the general price level.

Disinflation happens, for example, after a period of higher inflation in what are normally considered low inflationary economies and often is initially popularly confused with deflation. During disinflation many prominent prices, for example, oil, fuel, property and food prices are falling, but, the general price level is still actually rising, albeit at a slower rate than during normal low inflation. When the slowing annual inflation rate (slowing increase in general price level) moves lower and lower it eventually gets to a zero percent annual rate. When the general price level moves even lower past zero percent, the absolute value of the general price level decrease; i.e. the economy switches over from inflation to deflation: not just a slower increase in the generally increasing price level as during disinflation but actually a sustained decrease in the absolute value of the general price level below zero percent inflation which causes an increase in the real value of money and other monetary items: deflation.

Countries, excluding Japan, have little experience of deflation. Deflation is generally regarded as a very serious economic problem that everyone is trying to avoid at all costs especially after what happened during the Great Depression. Japan, however, has been moving in and out of deflation over the last 15 years or more.


Nicolaas Smith

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