Inflation and deflation

Entry Notes

Posted: 10252006
Author: Devin Mavro
Category: Taxes

Inflation presents itself as an overall rise in the general price level, meaning that the average level of all prices is rising, rather than the prices of a select few goods and services. A closer examination suggests that inflation is a decrease in the value (purchasing power) of a unit of money, perhaps because of an increase in the supply of money relative to demand. Deflation is the reverse—a fall in the average level of prices. History appears to be inflationary, although episodes of deflation are numerous.

Inflation is measured by the growth rate in price levels calculated as weighted averages of prices of a spectrum of goods and services. In the United States the Gross Domestic Product Deflator (GDPD) measures the price level for all goods and services, including factory equipment and other goods bought by businesses, luxury goods, and goods bought by the government. Another index, the Consumer Price Index (CPI), measures the price level for goods and services that are associated with the basic cost of living, including food, gasoline, utilities, housing, clothes, etc.

Wartime government expenditures can nearly always be counted on to create inflationary pressures, as happened in the United States during World War II. At that time the U.S. government enacted wage and price controls to contain inflation. The price controls were lifted at the end of World War II, but inflation remained a problem throughout the cold war era. Inflation tends to become a problem whenever governments do not want to levy the taxes sufficient to support government expenditures.

Economists often see controlling inflation as a problem in maintaining the value of money, which rises in value, as the money supply is restricted. In the 1980s a prolonged reduction in the growth of the money supply ended the inflationary inertia in the United States economy.

A slow steady rate of inflation that is easily anticipated causes less disruption than high inflation rates showing substantial volatility. Inflation in the range of 300 percent annually or higher is called hyperinflation. This brand of galloping or runaway inflation is often associated with the complete breakdown of society.

The last quarter of the nineteenth century saw deflation in the United States and several European countries. Deflation puts a burden on debtors, who find it harder to earn money to repay debts that remain fixed in value as wages and profits fall. In the late nineteenth century debtor hardship attributable to deflation fueled a populist revolt in the United States that nearly propelled William Jennings Bryan to the presidency. Bryan decried the gold standard as “crucifying” mankind on a cross of gold. The supply of gold was not keeping pace with rapid increases in production due to technology, causing the supply of goods to increase faster than the supply of money. Prices fell and Bryan proposed to increase the coinage of silver, adding to the money supply and easing deflationary pressures.

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