Inflation has been on the rise in many different countries around the world, with inflation rates being higher than normal after the global pandemic. Inflation has seen a significant resurgence, especially in the United States with rates as high as 6.2%, a 30-year record. Despite inflation rates being on the rise, some countries are experiencing a period of deflation, such as Japan. But what exactly is the difference between inflation and deflation and how it impacts the economy? Read more for the differences.
What’s Inflation
Inflation refers to the increase in the cost of goods and services in a country’s economy over a period of time. It is a measure of how much the price has increased. The rise of the inflation rate also corresponds to the reduction of purchasing power or how much individuals in a country can stretch their funds.
What’s Deflation
The opposite of inflation is deflation, which is the decline in prices for goods and services in an economy, which is also a negative inflation rate. Consumers in the market will typically see their funds go further when it comes to the cost of everyday goods and services. A healthy and typical inflation rate is about 2% – 3% and is generally what central banks of many countries try to aim for.
Although inflation and deflation are the opposites of each other, the extremes of both ends of the spectrum can severely impact the economy. When high inflation occurs, many consumers will see a drastic increase in the cost of living, from basic necessities and services, with many consumers reducing their purchases due to the increased costs. Many parts of the world are currently experiencing higher than normal inflation rates, such as the United States, Canada, and Australia due to the impact of the global pandemic.
Deflation, on the other hand, increases consumers’ purchasing power, as it decreases the costs of goods and services, at the cost of lower corporate revenue and profit. The decreased revenue and profit leads to less spending and less investment by companies. Some consumers may even delay their purchases with the assumption of purchasing cheaper goods in the near future, further exasperating the problem. Both are healthy for an economy within reason, the problem arises when inflation and deflation increase to significant levels.
Many economists around the nation are debating the impact of the newly released inflation report. The information that was released shows an inflation rate of 6.2%, which is a 30-year record, and whether it is sustainable in the short to medium term without having a drastic impact on the overall economy. The rise of the inflation rate has been attributed to several key reasons, most of which are brought on by the impact of the global pandemic, either directly or indirectly.
One of the problems that global economies experienced was a significant disruption of their logistics, which had a severe impact on many goods and services, increasing their costs, called cost-push inflation. Demand-pull inflation, which arises when the demand of products and services exceeds the supply can also be seen in select, but vital industries. The few vital industries that are pushing inflation to record levels are the car industry, real estate, and the stock market.
Another reason for the increased inflation rate is the low-interest rates. Currently, real estate mortgages are at almost record low levels and are compelling home buyers all across the nation to buy homes or second homes to lock in their low-interest rates. The low-interest rate is not only compelling home buying, many current home owners are also refinancing their mortgages for lower rates, introducing more capital in the markets. Corporate borrowing has also increased due to the low-interest rates, with many companies issuing stock buybacks for example.
The biggest reason for the rise of inflation is due to the increase in capital being introduced into the economy, not just in the United States, but in many countries around the world. The CARES act of 2020, at the start of the pandemic, introduced about $2 trillion in capital into the market, in the form of unemployment benefits for employees, corporate assistance, and loan programs designed to help businesses stay afloat during the pandemic as many cities and states closed many different businesses to reduce the spread of Covid-19.
As a result, many individuals and businesses have taken loans to expand their business operations or to start a new business. The increased loan distributions have also increased the total amount of capital in the market, leading to an increase in the inflation rate. The current administration has also recently introduced the infrastructure bill with a value of $1.2 trillion with the aim of improving infrastructure all across America, across several different sectors and industries such as transportation, broadband, utilities, roads, public transit, and highways.
With the previous CARES act and the current infrastructure bill, along with significant disruptions in logistics around the world, the United States will continue to experience a higher than the typical inflation rate.
Economic scholars and economists are currently talking about the increasing inflation rate, but few are mentioning the risk of deflation. Cathie Wood, the founder, and CEO of Ark Invest says that inflation is not the main risk that economists should worry about within the next 5 years. She argues the main risk to the economy in the next few years is actually deflation. She said that instead of 10-year treasury yields rising drastically similar to what happened during the 2008 financial crisis, the current bond market “has settled down” following a sharply higher move in yield earlier this year on fears of inflation and the fear of higher taxes on capital gains.
Cathie separated her argument into two main parts, good deflation, and bad deflation. Part of the good deflation Cathie says is the advances in DNA sequencing can also lead to lower healthcare costs, which would have an impact on the prices by as much as 20% in the economy. Battery packs are another good example of good deflation she says. “For every cumulative doubling of capacity in battery packs for electric vehicles, costs drop 28%,” she says. Artificial intelligence (AI) is also part of Cathie’s future prediction. With a decline in training costs of AI by 37% to 50%, she expects more and more businesses to implement AI, from every sector, industry, and company.
Part of her bad deflation prediction includes companies that simply do not keep up with tech and innovate. She says, “Those companies spent the last 20 years catering to short-term investors, who wanted their profits and they wanted them now, companies that were leveraging up to buy back shares and not investing enough in innovation.” The example she uses is electric cars. Cathie predicted the commercialization of electric cars in 2014 as being only 10 years away, with many automotive companies not trying to innovate. “Now we see auto manufacturers are scrambling and I would even say scrambling for dear life,” Cathie said.
The final source of deflation according to Cathie is falling commodity prices which will happen at the end of this year or next year. Cathie expects inventories to build to a level that is above demand next year and the unloading of the commodities will push prices down.
Currently, the United States is experiencing rates of inflation not seen in 30 years, with the rate rising every quarter. The reason for the increase in inflation can be attributed to many different factors, such as rising wages, record low-interest rates, record real estate sales, the CARES act and in the near future, the recently approved infrastructure plan. The inflation rate will continue to rise for the foreseeable future and the United States will not see deflation at the current rate.
Cathie mentions several aspects that support her theory of deflation in the years to come. However, with the current rate of spending and logistical problems persisting, the rate of inflation in the near future can be high enough that it would overshadow deflation. This is because the sectors and industries that are experiencing high rates of inflation are essential parts of life in the United States, while the sectors and industries Cathie provides as evidence of deflation, while important, do not permeate American life the same way automobiles, real estate, and groceries do. Due to all of these factors, inflation will continue to rise for years to come. Get ready for inflation by being prepared, read Protecting Your Assets Before Inflation Sets in.
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