Is inflation preferable to deflation? Before we can delve into the pros and cons of each, we must first consider what these terms really mean. Inflation is the sustained rise in the general price level over time, which means that the cost of living increases and the purchasing power of money decreases (central banks aim for 2% yearly inflation). Deflation is the opposite; where the average price level in the economy falls, there is a negative inflation rate. During a deflationary period, the general level of prices throughout the economy fall thus increasing the purchasing power of any given amount of currency. This has several impacts on different groups of people and institutions. If wages remain constant during this time, there is an increase in purchasing power for people who receive a salary, which leads to an improvement in the standards of living of people in society. Furthermore, people with savings benefit from deflation as their savings, even though in terms of money they remain at the same amount, That same amount is able to purchase more goods, which means that their wealth has increased.
In addition, deflation encourages saving as people expect prices to be lower in the future. This means that in the event of something unfortunate happening such as losing one’s job, people have a safety net which may help them. On the other hand, not everyone benefits from deflation as borrowers may struggle to repay debt. This happens because if the value of money has increased, the value of the initial borrowed amount, even if it remains constant, will also have increased, thus it may be more difficult to repay. Not only individuals but governments also fall prey to this effect as inflation causes the total amount of money raised through taxes to decrease which means governments could end up defaulting on their bond payments. Moreover, there is another risk associated to deflation known as a “deflationary trap” which occurs as a result of people delaying spending and saving money because of the expectation that in the future prices will be lower which decreases the aggregate demand lowering prices even further and initiating a vicious cycle of deflation which is very difficult to stop.
So what about inflation? During a period of inflation, there is an increase in the general level of prices throughout the economy, thus increasing the purchasing power of any given amount of currency. This too has a wide range of impacts on different groups of people and institutions. If wages remain constant, people’s purchasing power falls, as their cost of living increases while their income doesn’t. This means that the general standards of living decrease. Also people with savings suffer the most as their savings lose value, which means that their saved amount can no longer purchase the same amount of goods and services as it could several years back. This incentivises consumption because of the expectation of prices rising which means that saving is discouraged. Therefore, people avoid saving which means that if their source of income was disrupted by for example losing their job, they would not have a safety net that would help them until they found another job. Moreover, due to the increased consumption, aggregate demand increases which pushes prices even higher creating an inflationary spiral. On the other hand, individuals and institutions who have debt benefit from inflation as it makes it easier for the money owed to be payed back. For governments, inflation increases the amount of money that is raised through taxes which means that it will be able to fulfil the bond payments. In addition, wealthier individuals who usually hold their wealth in assets such as real estate or stocks benefit from inflation as their assets increase in value which makes them wealthier. This effect is enhanced by the fact that due to fears of inflation, people invest their money in stocks, creating pressure to the upside which benefits anyone who was holding the stocks from before.
It is not possible to determine if inflation is always preferable to deflation as certain people benefit from inflation while being negatively affected by deflation and vice versa. Regular people with a salary benefit from deflation as it encourages them to save, increases the purchasing power of their salary and savings and improves their standards of living. Wealthier people with assets lose wealth to deflation as their assets lose their value and become wealthier thanks to inflation due to the opposite. Governments are the institution which is most gravely affected by deflation and benefits the most from inflation. This happens because inflation is used as an instrument to take wealth from the population by the state in order to pay for state funded services such as public education, healthcare or the military without the need of rising taxes and hence without losing votes to this idea. Politicians, in order to gain popularity, promise to give the population many things they want such as pensions or healthcare, but to actually provide these things a huge amount of funding is required that would be expected to come from taxes, which are of course generally disliked. In order to obtain this funding, governments resort to going into debt by issuing bonds which are bought by central banks with newly created money. This increase in the money supply devalues it, which means that, ultimately, the wealth which cannot be extracted from this is extracted from the citizens. To legitimise this process, inflation is declared to be healthy and necessary for a functioning economy thus minimising any possible discontent caused by the increase in prices and the decrease in the standards of living, which preserves the popularity of the politicians. Furthermore, due to this system, most western democracies run a perpetual deficit in their budgets which is sustained by issuing government bonds in order to fulfil the payments for the previous bonds and devaluing their currency to the detriment of their citizens who fall victims to this huge Ponzi scheme.
In conclusion, nobody really benefits from inflation but the government, the very wealthy and people who take on debt. Jaime G, Year 13
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