Disinflation is a decrease in the rate of inflation. The rate of inflation is measured by the percentage change in the price level from one year to the next. When the rate of inflation decreases, economic growth slows and the cost of living becomes less expensive.
Disinflation is usually a result of the central bank controlling the money supply and reducing the amount of money available in the economy. This decreases the purchasing power of money and lowers the rate of inflation. Other factors can also contribute to disinflation, such as an increase in the supply of goods and services and an increase in the productivity of businesses which drives down prices.
In order to measure disinflation, economists look at the Consumer Price Index (CPI). The CPI measures the average change in the prices of goods and services over a given period of time. If the CPI shows that the average prices of goods and services are decreasing, then this is a sign that the rate of inflation is decreasing.
Overall, disinflation is a decrease in the rate of inflation and is usually caused by the central bank controlling the money supply. It can also be caused by an increase in the supply of goods and services and an increase in the productivity of businesses. The Consumer Price Index (CPI) is the main tool economists use to measure disinflation.
Example of Disinflation
In 1997, the rate of inflation in the United States was 2.3%. By 1999, it had decreased to 1.6%. This is an example of disinflation, as the rate of inflation decreased over a two year period. This decrease in the rate of inflation was caused by the Federal Reserve controlling the money supply and increasing interest rates. This decreased borrowing, which lowered the demand for goods and services, and drove down prices.
Formula of Disinflation
The formula for calculating disinflation is:
This formula measures the percentage change in the rate of inflation between two years. If the current year rate of inflation is lower than the previous year rate, then there is disinflation. If the current year rate is higher, then there is inflation. If the current year rate is the same as the previous year, then there is no inflation or deflation.
When to use Disinflation
Disinflation can be a useful tool for managing economic growth. It can be used when an economy is experiencing high levels of inflation and monetary policy is not able to contain it. Lowering the rate of inflation can help to stabilize the economy and reduce the cost of living. It can also help to reduce the risk of a recession or financial crisis.
Disinflation can also be used as a tool to stimulate economic growth. By reducing the rate of inflation, businesses can reduce their prices and increase their profits. This can lead to increased investment and employment, which can help to boost economic growth.
Types of Disinflation
There are two primary types of disinflation: demand-pull disinflation and cost-push disinflation.
- Demand-pull disinflation occurs when the demand for goods and services decreases and the supply remains unchanged, resulting in prices dropping. This type of disinflation is often caused by a decrease in consumer spending or a decrease in the money supply.
- Cost-push disinflation occurs when the cost of production increases, resulting in prices increasing. This type of disinflation is often caused by an increase in wages, taxes, or the cost of raw materials.
Both types of disinflation can lead to economic slowdown, as the decrease in prices reduces consumer spending and reduces economic growth.
Steps of Disinflation
- The central bank controls the money supply and reduces the amount of money available in the economy. This decreases the purchasing power of money and lowers the rate of inflation.
- An increase in the supply of goods and services. This leads to increased competition and lower prices.
- An increase in the productivity of businesses. Businesses become more efficient and produce goods and services at a lower cost, driving down prices.
- The Consumer Price Index (CPI) is monitored. If the CPI shows that the average prices of goods and services are decreasing, then this is a sign that the rate of inflation is decreasing.
Advantages of Disinflation
- A decrease in the rate of inflation is beneficial for the economy because it reduces the cost of living and increases people's purchasing power.
- When the rate of inflation decreases, it also encourages businesses to invest as they will have access to more capital.
- Disinflation can also help to reduce unemployment as businesses will have more money to hire new employees.
Limitations of Disinflation
Despite the potential benefits of disinflation, there are some limitations that should be taken into consideration.
- Disinflation can cause a decrease in economic growth, as it leads to a decrease in demand.
- Disinflation can cause a decrease in wages, as businesses may reduce wages in order to keep prices low.
- Disinflation can cause a decrease in investment, as businesses may be reluctant to invest in new projects if their profits are decreasing.
- Disinflation can lead to a decrease in employment, as businesses may be unable to afford to keep employees.
Disinflation can also be addressed using a variety of other approaches. These include:
- Fiscal Policy: Fiscal policy involves the government increasing taxes and reducing public spending. This lowers demand in the economy and reduces the rate of inflation.
- Monetary Policy: Monetary policy involves the central bank increasing interest rates and decreasing the money supply. This reduces the purchasing power of money and slows down economic growth, which in turn lowers the rate of inflation.
- Supply-Side Policies: Supply-side policies focus on increasing the supply of goods and services in the economy, which can help to drive down prices and reduce the rate of inflation.
Overall, disinflation can be addressed using a variety of approaches, including fiscal policy, monetary policy, and supply-side policies. These approaches can help to reduce the rate of inflation and make the cost of living more affordable.
|Disinflation — recommended articles|
|Deflation gap — Inflationary gap — Reflation — Demand-pull inflation — Ratchet effect — Galloping inflation — Underconsumption — Supply shock — Stabilization policy|
- Ghosh, M. A. R., & Phillips, M. S. (1998). Inflation, disinflation, and growth. International Monetary Fund.
- Acharya, V. V., Crosignani, M., Eisert, T., & Eufinger, C. (2020). Zombie credit and (dis-) inflation: evidence from Europe (No. w27158). National Bureau of Economic Research.