In economics both inflation and deflation refers to changes in prices of goods and services purchased by the consumer, however the effect of inflation and deflation on the consumer as well as on the economy is completely different. Given below are some of the differences between inflation and deflation –
- Inflation refers to general rise in prices of goods and service, whereas deflation refers to fall in price of goods and services. It can be better understood with the help of an example suppose you go for purchasing day to day products and it costs you $100, next week same set of products cost $105 then this $5 increase in your bill is called inflation and if the same set or products cost $95 then this $5 dollar decrease in your bill is deflation, while this is an simple example in real life calculation of inflation and deflation is not that simple and as it involves multiple variables.
- In order to counter inflation government use various policies to decrease the supply of money in the economic system like increasing rate of interest in banking system, reduction in expenditure by government and so on. Whereas in order to counter deflation government use various policies to increase the supply of money like decreasing the rate of interest in banking system, increasing of expenditure by government and so on.
- During inflation the real value of money or cash falls and therefore those who hold cash or liquid investments are at loss, while in deflation the real value of money or cash increase and therefore it benefits the holders of cash or liquid investments.
- While inflation is beneficial for borrowers because as inflation begin to rise the real value of money falls which implies that borrowers have to pay less in future due to concept of time value of money, while as far as deflation is concerned it hurts the borrowers and favors the savers.
- While inflation does not result in contraction of economic activity and in a way a moderate inflation along with growth is considered good for an economy whereas deflation can actually result in contraction of the economic activities which is never a good sign for any economy and hence an economy can get away with inflation, however as far as deflation is considered it can actually result in destabilization of economy of the country.
As one can see that inflation and deflation are two sides of coin and it is necessary for a government of a country to maintain a balance between the two, if government wants to maintain healthy growth rate along with general well being of the people of the country.