What Is Disinflation?

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Disinflation (wallstreetmojo.com)

It can be a result of an economic slowdown or a recession. It can also be due to a contractionary monetary policy, where the government aims to reduce the money supply, possibly due to extremely high inflation rates. Another economic scenario, reflation, is considered the opposite of disinflation.

Key Takeaways

  • Disinflation can be referred to as the phenomenon where the increase in the price of goods and services reduces comparatively. Thus, the price doesn’t decrease, but the speed of inflation decreases.It is not a harmful situation but a sign of a healthy economy. It is also beneficial for consumers. It will mostly recover automatically and helps solve higher inflationary periods.The concept is frequently compared to other similar economic scenarios like deflation, stagflation, reflation, etc. However, all these are significantly different from each other.

Disinflation Explained

Disinflation is a widely studied concept in economics. It is as essential as inflation, and its thorough understanding can be beneficial in monitoring and controlling various economic processes.

Look at the disinflation graph shown below. The inflation rate has increased constantly, and at a certain point, it decreased and started falling. It is to be noted that the disinflation graph is plotted by taking the inflation rate against time.

Now, let’s understand the difference between disinflation and deflation. The latter implies a fall in prices, whereas the former means a fall in a rise in prices. For example, a food item on December 2021 is $5. The price increased by $1 every month.

Suppose, from July 2022, the price only increased by $0.5; this is disinflation. There is still a price rise, but the rate has decreased, i.e., from $1 to $0.5. It was further noticed that from October 2022, the price started falling by $0.75 every month, meaning deflation.

Let’s move on to a related concept – reflation. It refers to a return to an initial or previous inflation rate. For instance, in the example given above, if the price increased by $1 every month from 2023, it would be a reflation.

Hence, it is possible to understand the importance of disinflation. Such a situation brings economic balance. Prolonged periods of constant inflation will increase the cost of living and make commodities unaffordable for most people. But a constant fall in prices or prolonged periods of deflation isn’t good either and indicates that the economy is stagnant or exhausted. Therefore, a balance of these two indicates a near-perfect economy.

Causes

Disinflation can be caused due to many economic factors. Firstly, the government can implement a contractionary monetary policy when inflation is dangerously high in an economy. To slow down inflation, the central bank can reduce the money supply. This will reduce demand and, consequently, the hike in prices. It might even lead to deflation if left for a long. Secondly, an economic recession or even a slowdown can reduce consumer spending. Again, when demand falls, price does too.

Factors

Now let’s look at the factors that arrest the rise in prices. Most of these factors are similar to inflation, but they act differently. Nevertheless, let’s look at them briefly.

  • Consumer spending – This implies the amount consumers spend on goods and services. Hence, if people spend more, the demand increases, thus pushing up the price. Conversely, if people spend less, the price increase would be arrested before reversing the direction.Money supply – The amount of money circulating in an economy can affect the prices of goods and services in many different ways. One of the most well-known methods is forcing consumers to spend less through various policies.Government regulations – The money supply in an economy is subject to constant monitoring and control by the government and the central bank. It involves a contractionary or an expansionary fiscal policy, the former restricting price rise.Employment and wage growth – These, too, are factors behind disinflation; but they are more likely to cause deflation than the former. But, to an extent, they can reduce people’s buying ability and thus discourage a price increase.

Effects

Disinflation has both positive and negative consequences. They are as follows:

#1 – Positive effects

It halts the increase in prices, which is most favorable for consumers. Thus, it protects the value of their money and enables them to save more. Moreover, a certain amount of disinflation is necessary to ensure the economy doesn’t overheat. Also, it shows economic contraction, which is another necessity in the functioning of an economy.

#2 – Negative effects

A slowdown in the pace of inflation is good until the prices tumble down and change direction, leading to deflation. Then, it is good if the policies aim to reduce the money supply and decrease the inflation rate. But the balance between disinflation and deflation is essential. Hence, constant control and monitoring are required. Further, if it is caused by a moderate to severe economic recession, it might be dangerous to the economy.

Example

Here’s recent news about disinflation expectations. Fears over inflation and economic recession have been prevalent worldwide for almost a year. But July and August 2022 have seen some variations in specific macroeconomic trends. Oil prices decreased to below $4 per gallon for the first time since the Russia-Ukraine war. Also, the producer price index (PPI) on both finished goods and final demand showed a sharp decline.

The graph here shows the PPI trend in the United States and is a positive sign signaling a possible slowdown in price rise.

Unemployment is increasing too, and economists hope that lesser demand in the labor market can help push wages and prices down. However, increments for those employed, too, have decreased.

Stagflation vs Disinflation

Stagflation is the phenomenon where economic stagnation and inflation co-occur. Hence, an increase in prices will be accompanied by slowing economic growth. It usually takes place in conditions of economic recession.

Stagflation can be extremely dangerous and has many harmful effects, like negative economic growth, high unemployment, etc. But, contrary to this, disinflation is not harmful in most cases and is a mere fall in the speed of price rise.

This article has been a guide to what is Disinflation and its meaning. We explain the topic, its causes, factors, effects, an example, and its comparison with stagflation. You may also find some useful articles here –

Deflation refers to the fall in prices. The economic prices reverse their direction, whereas, in disinflation, the prices would still be increasing, but the rate of increase would fall. Also, deflation is considered more dangerous.

The slowing pace of the rise in prices can be due to an economic slowdown or a tighter monetary policy implemented to reduce the money supply in an economy to solve higher inflation. Thus a fall in consumer spending or consequent decrease in demand, too, can be important reasons.

The popular opinion is that the cost of disinflation is zero, which is mostly true. More often, a fall in the pace of inflation is a relief to most consumers and a positive indicator of economic health. However, if left unchecked, it could lead to deflation and, thus, affect the economy.

  • Deflation vs DisinflationInflation vs RecessionDeflation