Our economy is a result of the implementation of systems and politics over the course of centuries ! So it is quite complex to grasp. However, there are a few terms that we usually hear here and there in the media — especially since the 2008 financial crisis.
Inflation, deflation and stagflation are three terms that refer to the purchasing power of people when prices of products, goods and services change. They are all regulated by governments’ monetary policies.
What is inflation ?
Let’s say that there were only 10 cars to buy on the whole planet — thank God it’s not actually the case — and that overall there were only $100 available. What would the price of a car be ? Naturally, a car would cost $10 — if only that could be the case.
Now, if we printed $100 more and still only had 10 cars to buy, the price of a car would be 200 / 10 = $20. So with more money available but the same amount of goods, the price of those goods rose.
So monetary inflation is an increase in the quantity of money available meaning that when there’s an inflation, you need more money to buy the same amount of goods you were able to buy before.
If the money supply is higher than the demand for goods and services then prices rise and your purchasing power is weakened. You then have monetary and price inflation — which is the GENERAL increase in the price of goods and services.
However, if the money supply increases hand in hand with the demand for goods and services — their supply — then prices don’t rise. You then have monetary inflation without price inflation.
Indeed, — first example — if suddenly you had 20 cars to buy with an increased amount of money — $200 — then the price of a car is 200 / 20 = $10. It didn’t change despite a higher money supply.
In the same way, if you had $100 available and out of the 10 cars 5 were destroyed — for whatever reason — than the price of a car would be $20. That’s price inflation caused by a low supply of goods and services.
Is it a good thing ?
Well countries generally tend to keep a 2-3% annual inflation rate. Indeed, if there’s inflation it means that there is more money available to buy fewer goods and services. This increases production — the creation of goods and services — and is very good for the Gross Domestic Production — or GDP — of a country.
What is deflation ?
Well, it is the opposite of monetary inflation meaning that it is a decrease in the supply of money circulating in the economy. Similarly, price deflation is the GENERAL decrease in the prices of goods and services.
Using the first example, if there were 10 cars in the whole world to buy with less money — let’s say $50 — it means that the price of each car would be 50 / 10 = $5.
Okay, understood. But is deflation actually a bad thing ?
Well generally yes it is. You can find the various reasons why right here in this 2 min video.
What is stagflation ?
It is a combination of slow economic growth — which “ is an increase in the capacity of an economy to produce goods and services, compared from one period of time to another ” — and high unemployment rates associated with rising prices or inflation, or inflation and a decline in GDP.
If there’s anything you would want to add or share, please do so in the comment section :). I am learning as I write these articles so don’t hesitate to correct me if I said something wrong.
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