Inflation versus Deflation

Inflation and hyperinflation

By the time the popular Venezuelan government called for next economic measures to end rampant hyperinflation at the end of 2018, the local currency had become virtually worthless.

After 80,000% inflation over the previous year, it took more than 6 million bolivars to buy a loaf of bread - that is, if you could find a store that had a loaf of bread in stock.

After more than a decade of economic mismanagement, the financial meltdown has become so bad that by the late 2010s, clean water distribution had slowed to a trickle, and gravely sick citizens were dying in make-shift hospitals, unable to get the treatments that were keeping people alive in almost every other country in the world.

It is nearly impossible to index prices and salaries in the chaotic world of hyperinflation, and consequently, no one is left untouched by uncontrolled inflation. 

• From the top 1% to the poorest of the poor, an economy in crisis eventually hurts virtually everyone.  
• But it's the most vulnerable who suffer the most.  When the cost of a loaf of bread exceeded the total monthly minimum salary in Venezuela, those at the bottom of the economic ladder had to face the worst aspect of economic hardship:  starvation.  Millions ended up fleeing across the border as economic refugees to Colombia and Brazil.

Hyperinflation has ravaged countries as diverse as Germany, Mexico and Argentina - even China during the Yuan dynasty, where too much paper money in circulation led to uncontrolled inflation.  In Germany's postwar Weimar Republic, in 1923, inflation became so bad that the government had to resort to issuing postage stamps worth fifty billion marks and people had to use wheel barrows to carry enough cash to make simple household purchases.

Deflation

The economic crisis in Japan at the beginning of the twenty-first century was marked by severe deflation, where a chronic decline in prices led to decades of sluggish economic growth.

When deflation was accompanied by a sharp decline in consumers - with the total population in Japan expected to decline precipitously by 2050 - the crisis in Japan appeared to be just as intractable as the inflationary crises in Venezuela and other parts of the world.  

• In a country with persistent deflation, consumers will simply stop buying goods and services as prices decline expecting to get a better price at some point in the near future.  
• Likewise, companies also tend to delay investments in new plants and machinery when they think prices for their products will soon decline.  
• In deflationary environments, companies try to find ways to reduce input costs, often leading to a reduction in salaries.  The lower salaries then translate into even lower consumer spending, completing the vicious circle of deflationary economic crisis.

The solution is to change long term expectations

The problem with too much deflation, just like to much inflation, is that growth screeches to a halt because of the economic uncertainty both problems create.

In periods of crisis, however, central banks are often unable to change the perception in the minds of consumers and business-people that there will be no end to the vicious cycle of inexorably rising or declining prices.  

The solution for deflation, as for hyperinflation, essentially involves finding a way to change long-term expectations - not an easy task in an economy out of control.

Neither too hot nor too cold

Like the Three Bears' porridge, an economy should be neither too hot nor too cold.  

Neither acute inflation nor acute deflation are positive for sustainable economic health.

Despite the desire of some populist leaders to have a high inflation rate of 3 or even 4%, most economists recommend a "just right" inflation rate of about 2% per year.