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Economy Concepts:

Inflation and Deflation:


What is inflation?
Inflation is simply a measure of the extent of increase in
prices. If potatoes cost Rs.100 per kg in August 2014, and if
they cost Rs.110 per kg in August 2015, then inflation in
the price of potatoes was 10 per cent.
When this happens across prices of all commodities for a
relatively sustained period of time, then one can say the
economy is experiencing inflation. Looking at consumer
prices, India is still undergoing inflation. That is, prices are
still increasing. For example, in August 2015, overall
consumer prices were 3.7 per cent higher than they were in
August 2014.
So, then what does it mean when the government says
inflation is coming down?
All that means is that the rate of increase of prices is
slowing. Going back to the example of potatoes, if they
were Rs.110 per kg in August, then went to Rs.120 per kg in
September, Rs.125 in October and Rs.127 in November,
one can see that although the price is still going up, the rate
of increase is decelerating.
Is there a technical term for such a phenomenon?
The U.S. Federal Reserve often uses the term disinflation
to refer to a period where the rate of inflation has been
slowing on a sustained basis.

So, looking at the Consumer Price Index, India is currently


technically going through a phase of disinflation. The rate
of inflation as measured by the CPI was 10.7 per cent in
August 2013, which came down to 3.7 per cent over the
course of two years.
So, then, what is deflation and why is there so much
controversy and confusion around the term?
Deflation is simply the opposite of inflation. That is, prices
fall from one period to the next. The confusion comes from
the fact that deflation has historically generally been
accompanied by significant economic contraction. But that
is not the case in India.
Real GDP growth, the final figure that the government
presents to you, is calculated by looking at how the value of
the total production of the economy has changed compared
to the previous year, and then reducing the effect of
inflation/deflation from this. If the rate of growth of the
economy and prices are both falling, then that is not a good
place to be in as it is usually accompanied by rising
unemployment, lower demand, falling corporate earnings,
reduced investments, etc.
This gets exacerbated when people begin to expect
prolonged deflation. If they expect that prices will be lower
in the future, then people and companies both defer their
investments and expenditure waiting for those lower
prices. This postponement of expenditure hurts the
economy. But slowing inflation coupled with about 7 per
cent GDP growth and a pickup in domestic demand as
India is experiencing now is not a bad thing in itself.

Following an extended period of double-digit inflation, this


cooling off of prices may just be a correction.
Fun fact
There is such a thing as hyperinflation, when the rate of
increase of prices is beyond anything seen in normal
circumstances. As one website succinctly defines it,
Hyperinflation is a situation where the price increases are
so out of control that the concept of inflation is
meaningless.
One famous example of hyperinflation was when French
and Belgian troops invaded the industrial regions of the
Weimar Republic (of World War I fame) to ensure the
payment of war reparations.
The Weimar Republics currency, the Mark, was at 320
Marks per dollar in the first half of 1922. By November
1923, the exchange rate was at 4,210,500,000,000 Marks
per dollar.