Deflation vs. Disinflation: What's the Difference

By STEVEN NICKOLAS
Updated Apr 19, 2019

Deflation vs. Disinflation: An Overview

Although they may sound the same, deflation should not be confused with disinflation.

Deflation is a decrease in general price levels throughout an economy, while disinflation is what happens when price inflation slows down temporarily.

Deflation, which is the opposite of inflation, is mainly caused by shifts in supply and demand.

Disinflation, on the other hand, shows the rate of change of inflation over time. The inflation rate is declining over time, but it remains positive.


KEY TAKEAWAYS

Deflation is the drop in general price levels in an economy, while disinflation occurs when price inflation slows down temporarily.

Deflation, which is harmful to an economy, can be caused by a drop in

• the money supply, 
• government spending, 
• consumer spending, and 
• corporate investment.

Central banks will fight disinflation by

• expanding its monetary policy and 
• lowering interest rates.

Disinflation can be caused

• by a recession or 
• when a central bank tightens its monetary policy.

***************************************************

Deflation

Deflation is the economic term used to describe the drop in prices for goods and services.

Deflation slows down economic growth.

It normally takes place during times of economic uncertainty when there is demand for goods and services is lower, along with higher levels of unemployment.

When prices fall, the inflation rate drops below 0 percent.


Deflation (and inflation) rates can be calculated using the consumer price index (CPI). This index measures the changes in the price levels of a basket of goods and services. They can also be measured using the gross domestic product (GDP) deflator, which measures the price inflation.

There are several different factors that can cause deflation, including a drop in the money supply, government spending, consumer spending, and investment by corporations.

Business productivity can also lead to a drop in prices.

• When a company uses more advanced technology in its production process, it may become more efficient, thereby reducing its costs. 
• These cost savings may then be passed on to the consumer resulting in lower prices.

Consider the case of mobile phones. Cellphone prices have dropped significantly since the 1980s due to technological advances. This has allowed supply to increase at a faster rate than the money supply or demand of cellphones.

But bonds can perform well during times of deflation.   More investors end up flocking to quality assets that promise a safer investment vehicle.

By contrast, it can have a negative effect on the stock market. A drop in prices—and, therefore, supply and demand—will hurt the profitability of companies, leading to the erosion of share value.

In order to deal with deflation, a central bank will step in and employ an expansionary monetary policy. 

• It lowers interest rates and increases the money supply within the economy. 
• This, in turn, boosts demand for goods and services. 
• Lower interest rates mean an increase in the spending power of consumers. 
• More spending means price inflation and, therefore, higher demand for goods and services. 
• Higher prices lead to higher profits for businesses.

Disinflation

Disinflation occurs when price inflation slows down temporarily. 

This term is commonly used by the U.S. Federal Reserve when it wants to describe a period of slowing inflation. 

Unlike deflation, this is not harmful to the economy because the inflation rate is reduced marginally over a short-term period.

Unlike inflation and deflation, disinflation is the change in the rate of inflation.

• Prices do not drop during periods of disinflation and it does not signal an economic slowdown. 
• While a negative growth rate—such as -2 percent—indicates deflation, disinflation is demonstrated by a change in the inflation rate from one year to the next. 
• So disinflation would be measured as a change of 4 percent from one year to 2.5 percent in the next.

IMPORTANT:  Disinflation isn't necessarily bad for the stock market, as it may be during periods of deflation. In fact, stocks can perform well when the inflation rate drops.



Disinflation is caused by several different factors.

• A recession or a contraction in the business cycle may result in disinflation. 
• It may also be caused by the tightening of monetary policy by a central bank. When this happens, the government may also begin to sell some of its securities, and reduce its money supply.

https://www.investopedia.com/ask/answers/032415/what-difference-between-deflation-and-disinflation.asp#:~:text=Deflation%20is%20a%20decrease%20in,shifts%20in%20supply%20and%20demand.&text=The%20inflation%20rate%20is%20declining%20over%20time%2C%20but%20it%20remains%20positive.

Disinflation

By WILL KENTON
Updated Sep 12, 2019


What is Disinflation?

Disinflation is a temporary slowing of the pace of price inflation.

It is used to describe instances when the inflation rate has reduced marginally over the short term.

It should not be confused with deflation, which can be harmful to the economy.


KEY TAKEAWAYS

Disinflation is a temporary slowing of the pace of price inflation.

Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.

A healthy amount of disinflation is necessary, since it represents economic contraction and prevents the economy from overheating.


Understanding Disinflation

Disinflation is commonly used by the Federal Reserve to describe a period of slowing inflation. 

Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.

Although sometimes confused with deflation, disinflation is not considered problematic because 

• prices do not actually drop, and 
• disinflation does not usually signal the onset of a slowing economy. 

Deflation is represented as a negative growth rate, such as -1%, while disinflation is shown as a change in the inflation rate from 3% one year to 2% the next.

Disinflation is considered the opposite of reflation, which occurs when a government stimulates an economy by increasing money supply.

A healthy amount of disinflation is necessary, since it

• represents economic contraction and 
• prevents the economy from overheating. 

As such, instances of disinflation are not uncommon and are viewed as normal during healthy economic times.

Disinflation benefits certain segments of a population, such as people who are inclined to save their earnings.


Causes of Disinflation

Several main reasons can cause an economy to experience disinflation.

• If a central bank decides to impose a tighter monetary policy and the government starts to sell off some of its securities, it could reduce the supply of money in the economy, causing a disinflationary effect. 
• Similarly, a contraction in the business cycle or a recession can also cause disinflation. For example, businesses may choose not to increase prices to gain greater market share, leading to disinflation.

Disinflation Since 1980

The U.S. economy experienced one of its longest periods of disinflation from 1980 through 2015.

During the 1970s, the rapid rise of inflation came to be known as the Great Inflation, with prices increasing more than 110% during the decade. The annual rate of inflation topped out at 14.76% in early 1980. 

Following the implementation of aggressive monetary policies by the Federal Reserve to reduce inflation, 

• the increase in prices slowed in the 1980s, rising just 59% for the period. 
• In the decade of the 1990s, prices rose 32%, 
• followed by a 27% increase between 2000 and 2009, and 
• a 9% increase between 2010 and 2015.

Stock Performance During the Period of Disinflation from early 1980 to 2015

During this period of disinflation, stocks performed well, averaging 8.65% in real returns between 1982 and 2015.

Disinflation also allowed the Federal Reserve

• to lower interest rates in the 2000s, 
• which led to bonds generating above-average returns.

The Danger of Disinflation

The danger that disinflation presents is when the rate of inflation falls near to zero, as it did in 2015, raising the specter of deflation. 

Although the rate of inflation turned negative briefly in 2015, concerns over deflation were dismissed because it was largely attributed to falling energy prices. 



[Some economists view the near-zero rate of inflation in 2015 as a bottom, with the expectation, or hope, the rate of inflation will begin to rise again. As of Jan. 2018, the rate of inflation stands at 2.1%, with projections for an increase to 2.38% later in the year.]


https://www.investopedia.com/terms/d/disinflation.asp

Tug of war between Deflation and Inflation: the most Challenging Investment Climate today

A Central Banker’s Worst Nightmare


#Inflation and Deflation

From a mathematical perspective, inflation and deflation are two sides of the same coin.

• Inflation is a period of generally rising prices. 
• Deflation is a period of generally falling prices.

Both are deviations from true price stability, and both distort the decisions of consumers and investors.

• In inflation, consumers may accelerate purchases before the price goes up. 
• In deflation, consumers may delay purchases in the expectation that prices are going down and things will be cheaper if they wait.

To investors, inflation and deflation are bad in equal, if opposite, measure.

But, from a central banker’s perspective, inflation and deflation are not equally bad. 

• Inflation is something that central bankers consider to be a manageable problem and something that is occasionally desirable. 
• Deflation is something central bankers consider unmanageable and potentially devastating. 

#Central banks fear deflation more than inflation

Understanding why central banks fear deflation more than inflation is the key to understanding central bank monetary policy today.

1.  Central bankers believe they can control inflation by tightening monetary policy. 

• Generally, monetary policy is tightened by raising interest rates. 
• Since rates can be raised to infinity, there is not limit on this tool. 
• Therefore, no matter how strong inflation is, central banks can always tame it with more rate increases.
• The classic case is Paul Volcker in 1980 who raised interest rates to twenty percent in order to crush inflation that had reached thirteen percent.  
• Central bankers feel that if the inflation genie escapes from the bottle, they can always coax it back in. 

2.  Central bankers also believe that inflation can be good for an economy.  

This is because of something called the Marginal Propensity to Consume or MPC.   The MPC is a measure of how much an individual will spend out of an added dollar of income.

• The idea is that if you give a poor person a dollar they will spend all of it because they struggle to pay for food, housing and heath care. 
• If you give a rich person a dollar, they will spend very little of it because their needs are already taken care of, so they are more likely to save or invest that dollar.  
• Based on this, poorer people have a higher MPC. 

3.  Inflation can be understood as a wealth transfer from the rich to the poor. 

• For the rich person, his savings are worth less, and his spending is about the same because he has a low MPC. 
• By contrast, the poor person has no savings and may have debts that are reduced in real value during inflation. Poor people may also get wage increases in inflation, which they spend because of their higher MPC.

4.   Therefore, inflation tends to increase total consumption because

• the wealth transfer from rich to poor increases the spending of the poor, 
• but does not decrease spending by the rich who still buy whatever they want. 

The result is higher total spending or “aggregate demand” which helps the economy grow.




#Deflation hurts the government in many ways

Deflation is not so benign and hurts the government in many ways.


1.  It increases the real value of the national debt making it harder to finance.

• Deficits continue to pile up even in deflation, but GDP growth may slow down when measured in nominal dollars. 
• The result is that the debt-to-GDP ratio can skyrocket in periods of deflation. 
• Something like this has been happening in Japan for decades. 
• When the debt-to-GDP ratio gets too high, a sovereign debt crisis and collapse of confidence in the currency can result.

2.  Deflation also destroys government tax collections. 

• If a worker makes $100,000 per year and gets a $10,000 raise when prices are constant, that worker has a 10% increase in her standard of living. 
• The problem is that the government takes $3,000 of the increase in taxes, so the worker only gets $7,000 of the raise after taxes.
• But if the worker gets no raise, and prices drop ten percent, she still has a ten percent increase in her standard of living because everything she buys costs less. 
• But now she keeps the entire gain because the government has no way to tax the benefits of deflation. 
• In both cases, the worker has a $10,000 increase in her standard of living, but in inflation the government takes $3,000, while in deflation the government gets none of the gain.

#What is good for government is often bad for INVESTORS.

For all of these reasons, governments favor inflation.   It can

• increase consumption, 
• decrease the value of government debt, and 
• increase tax collections. 

Governments fear deflation because

• it causes people to save, not spend; 
• it increases the burden of government debt, and 
• it hurts tax collections.

But, what is good for government is often bad for investors. 

In deflation, investors can actually benefit from

• lower costs, 
• lower taxes and 
• an increase in the real value of savings. 

As a rule, inflation is good for government and bad for savers; while deflation is bad for government and good for savers.

#Flaws in the thinking about inflation and deflation by the government and economists

There are many flaws in the way the government and economists think about inflation and deflation.

The idea of MPC as a guide to economic growth is badly flawed.

Even if poor people have a higher propensity to consume than rich people, there is more to economic growth than consumption. 


1.  The real driver of long-term growth is not consumption, but investment. 

• While inflation may help drive consumption, it destroys capital formation and hurts investment. 
• A policy of favoring inflation over deflation may prompt consumption growth in the short run, but it retards investment led growth in the long run. 
• Inflation is a case of a farmer eating his own seed-corn in the winter and having nothing left to plant in the spring. Later he will starve.

2.  It is also not true that inflation is easy to control. 

• Up to a certain point, inflation can be contained by interest rate increases, but the costs may be high, and the damage may already be done. 
• Beyond that threshold, inflation can turn into hyperinflation.  

3.  Hyperinflation

At that point, no amount of interest rate increases can stop the headlong dash to dump money and acquire hard assets such as gold, land, and natural resources. 

• Hyperinflation is almost never brought under control. 
• The typical outcome is to wipe out the existing currency system and start over after savings and retirement promises have been destroyed.

#Central banks favour inflation over deflation:  Its Implications

In a better world, central bankers would aim for true price stability that does not involve inflation or deflation.

But given the flawed economic beliefs and government priorities described above, that is not the case.

1.  Central banks favor inflation over deflation because it

• increases tax collections, 
• reduces the burden of government debt and 
• gooses consumption. 

If savers and investors are the losers, that’s just too bad.


2.  The implications of this asymmetry are profound.

• In a period where deflationary forces are strong, such as the one we are now experiencing, central banks have to use every trick at their disposal to stop deflation and cause inflation. 
• If one trick does not work, they must try another.

Since 2008 central banks have used

• interest rate cuts, 
• quantitative easing, 
• forward guidance, 
• currency wars, 
• nominal GDP targets, and 
• operation twist to cause inflation. 

3.  None of it has worked; deflation is still a strong tendency in the global economy. This is unlikely to change.  The deflationary forces are not going away soon.

• Investors should expect more monetary experiments in the years ahead. 
• If deflation is strong enough, central banks may even encourage an increase in the price of gold  in order to raise inflationary expectations.

4.  Eventually the central banks will win and they will get the inflation they want.

• But it may take time and the inflation may turn into hyperinflation in ways the central banks do not expect or understand. 
• This “tug-of-war” between inflation and deflation creates the most challenging investment climate in 80 years.

The best investment strategies involve a balanced portfolio of hard assets and cash so investors can be ready for both. 

What makes deflation such a dreaded condition

Deflation is an empty threat (so far)
In such a deep recession, the word is bound to come up. But a close look at the numbers shows that it's a long shot at this point.

Anthony Karydakis, Contributor
December 18, 2008: 9:37 AM ET

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This recession has been so unusual that it has brought back economic phenomena that haven't been seen in generations, at least not in the U.S. Chief among them is deflation. It's a scary prospect that has been on people's minds since evidence of a deepening recession started proliferating quickly earlier in the fall.
What makes deflation such a dreaded condition is that, once it takes hold, it motivates consumers to hold back on spending in the expectation that they will be able to buy things at a cheaper price later. This causes further drop in demand today, leading to more cutbacks in production and even slower economic activity, which feeds into more price declines -- a highly destabilizing dynamic.
Against that backdrop, the report earlier this week on November's Consumer Price Index (CPI) was eagerly anticipated, as it was likely to shed some light on whether such deflation fears are realistic in this environment. The anxiety over such a prospect had already been heightened by a sizeable decline (-1.0%) in the index in October and a highly unusual drop (-0.1%) in the so-called "core" CPI that month. (Core CPI is the overall index minus the notoriously volatile components of food and energy, which together account for about one-fourth of the total.)
So, with the stakes so high for the November report, what was the verdict?
On the face of it, the sharp 1.7% decline in the CPI last month (its biggest monthly drop ever and its fourth consecutive one since August) added fuel to the concerns that the economy may be about to get hit by powerful deflationary forces. Adding to that impression, the CPI is now up only 1.1% in the last 12-month period, while it was up by 3.7% in the 12-month period to October and 5.6% in the corresponding period to July.
So, there is no doubt that a major downtrend in the rate of inflation is already manifesting itself in strong terms. It is important, though, to draw a sharp distinction between the terms "disinflation" and "deflation," which are sometimes inadvertently lumped together. The first means a slower pace of inflation (that is, prices are still rising), while the second means an outright decline in the price level.
However, before jumping to the conclusion that deflation is around the corner, it's important to consider several factors that present a significantly less bleak picture.

Let's begin with some basic facts:
November's decline in the overall index was largely due to a 17% decline in energy prices and, specifically, a nearly 30% collapse in gasoline prices. However, excluding the food and energy components, the core index was flat for the month, despite a 0.6% decline in new vehicle prices, in line with dismal auto sales numbers reported in the last couple of months by all automakers. Several key categories (apparel, entertainment, medical care, shelter costs) all showed moderate increases, suggesting the absence of any broad-based downward pressure on prices.
So the inflation downtrend since July is largely the result of a dramatic decline in commodity prices (and particularly energy prices) and to a lesser degree the rebound of the dollar and the pullback in consumer demand. Looking ahead, it appears that the pace of erosion in commodity prices is slowing and the dollar's rebound is stalling, as the perceived depth of the U.S recession is raising some anxiety around the globe.
As a result, any further declines in the overall CPI are likely to moderate in the coming months. Still, there's a realistic probability that at some point in the next few months, the CPI will dip into negative territory on a 12-month basis and the word "deflation" will start appearing in headlines again.

The question that arises then is: Does this mean that the dreaded deflationary forces, which in the postwar era had visited only Japan among the major industrialized countries (for a protracted period starting in the '90s), have now reached the U.S. shore?
The answer is: not necessarily so, for two reasons:
1. A simple dip in the overall CPI for a few months into negative territory on a year-over-year basis is not tantamount to a full-fledged deflationary trend. For such a dynamic to emerge, it will take a more prolonged period of declining prices, which can only be achieved in the context of a lengthy and steadily deepening recession. This is not a totally unrealistic scenario, but it disregards the Fed's series of extraordinary measures (including Tuesday's decision to bring the overnight interbank rate down essentially to zero) and the massive domestic fiscal-stimulus program waiting in the wings. The combined effect of such unprecedented actions should help cushion any further downside risks beyond the first quarter of 2009.
2. A generally more reliable measure of inflation (although less popular in terms of broader public perceptions) is the core CPI, which, by excluding the two most volatile components (food and fuel) of the index, also tends to be dramatically more stable over time. True, the core index has also drifted lower since July but at a much more measured pace, 2% last month, down from 2.5%. Changes in the core index are very incremental on a month-to-month basis, so it is unlikely that it will slip into negative territory any time soon. In all likelihood, the economy will have already started showing signs of life by the time such a slow-moving downtrend brings the core CPI close to the feared zero mark.
It is exactly because of the less noisy nature of the core CPI that Fed officials tend to pay considerably more attention to that price measure--rather than the overall CPI--in addition to their favorite inflation indicator, the core PCE (Personal Consumption Expenditures) price index. Both of these measures are currently in the vicinity of 2% and unlikely to emanate any deflationary signals in the foreseeable future.
Naturally, the longer the recession drags on, the higher the risk that the current disinflationary trend will convert itself into a deflationary one. But the distance between the two is real and, at this point, the risk of the latter outcome -- beyond the phase of a simple arithmetic quirk for a short period--is indeed low.

Anthony Karydakis is a former chief U.S. economist with JP Morgan Asset Management and currently an Adjunct professor at New York University's Stern School of Business.

http://money.cnn.com/2008/12/18/news/economy/deflation_recession.fortune/