What Is the Difference Between Inflation, Deflation, and Disinflation?

Global economies experience periods of inflation, deflation, and disinflation as political climates and consumer perceptions change. Knowing these terms and getting your news from reputable sources can help you better understand what is happening in the world around you. Here’s what you need to know about inflation and its counterparts.

What Is Inflation?

According to the International Monetary Fund, inflation is “the rate of increase in prices over a given period.” Inflation is measured using the consumer price index (CPI) which tracks the average costs of various goods and expenses. For example, if a cart of groceries costs $100 one year and $110 the next year, inflation would be 10%.

There are multiple categories of inflation that are used to discuss the causes and effects of this economic concept. However, the big picture is that inflation refers to costs going up on a macroeconomic level.

Causes

Understanding why inflation occurs can help you track pricing trends and develop a better understanding of this concept. The Reserve Bank of Australia lists three causes of inflation:

• Demand-pull: This occurs when the demand for goods and services outweighs the supply. For example, limited housing inventory can drive up home prices.
• Cost-push: This is when the ability to supply goods is limited. When prices to produce goods increase, companies can’t produce as many goods. This causes prices to increase because of the reduced supply.
• Inflation expectations: This occurs when people think inflation will occur, causing them to preemptively raise prices.

Effects

Inflation affects the American economy in multiple ways. Here are a few examples of inflation changing consumer spending.

• Americans have less purchasing power: Because goods cost more, consumers can afford less with the same budgets.
• It costs more for companies to produce goods: Increased operating costs reduce profit margins.
• Companies sell less: Consumers can’t afford to buy as much, so companies sell fewer goods and services.

Changes in consumer behavior can also affect the economy at large. Inflation could potentially turn a bull market into a bear market. It also affects interest rates because inflation changes the financial stability, and therefore the level of risk, of borrowers.

Examples

Inflation can be found across multiple industries, but one of the most notable examples in recent years is the price of eggs. In 2023, a bird flu outbreak caused egg prices to soar across the United States because production plummeted. Supply was low and demand was high. The USDA reports the California benchmark for large eggs rose from $0.95 to $3.89 per dozen.

Another example is the shortage of construction workers. In 2023, the Associated Builders and Contractors said the industry needs 546,000 workers to keep up with demand. This reduces supply because construction companies cannot produce like they could while driving up production costs because they need to offer competitive wages. Overall, this makes construction projects more expensive.

Management Strategies

Governments and financial institutions have multiple strategies to counter inflation. These include:

• Removing barriers to work: This increases the number of workers in the economy, reducing labor shortages that drive up wage costs.
• Deregulating markets: This increases the speed of production, boosting supply.
• Removing barriers to international imports: This also increases supply while reducing the cost of goods for manufacturers.

Each of these strategies also comes with drawbacks. Deregulation and lowered barriers to work reduce protections for consumers and workers. Reduced tariffs also lower tax revenue.

What Is Deflation?

Deflation occurs when inflation slows and prices fall. It is the opposite of inflation because prices are dropping, increasing consumer buying power. Deflation refers to a sustained decrease in the price of goods.

Causes

As a whole, deflation is caused by a decline in demand or a sudden increase in supply. Here are a few in-depth causes of deflation:

• Supply increases: The Federal Reserve Bank of St. Louis uses oil supply as an example. When oil reserves are high, prices drop.
• Consumer shifts toward savings: When Americans spend less and save more, the demand for goods decreases.
• Changes in the stock market: Stock prices can affect how people perceive the economy and spend money.

Effects

Deflation has several negative effects on the economy and individuals. Here are a few issues that arise with deflation:

• Job loss: Declining revenues cause companies to reduce production. This leads to layoffs or vendors losing clients.
• Stagnant wages: Companies are less profitable, so they cannot pay their workers more.
• Loss in investments: Reduced profitability can lower company values, causing stock drops.

Examples

The price of crude oil is just one example of deflation. In 2022, prices peaked at $113.77 per barrel, causing gas prices to soar. A year later, the price-per-barrel was $68.59. When gas prices are high, Americans take fewer vacations, because both gas prices and airline tickets are expensive. However, changes in supply, which are often affected by international relations, can bring prices down again.

For another example, the holiday season is often used as an indicator of inflation or deflation. In 2020, holiday travel plummeted along with consumer spending. This further reduced the profits of retailers. However, holiday spending has since rebounded in recent years.

Management Strategies

Governments have multiple management strategies to fight deflation. Here are a few tools at their disposal.

• Lowering interest rates: This allows more people and companies to borrow money, increasing spending.
• Increases in government spending: The government can actively put money into the economy, giving it a boost.

These steps can increase demand for products, allowing companies to hire more workers and create jobs. Increased employment boosts spending.

What Is Disinflation?

Disinflation is the process of slowing inflation. It is the middle point between inflation and deflation. In February 2023, economics at the U.S. Federal Reserve called for controlled disinflation to counter high inflation rates. This is meant to preserve American buying power without leading to deflation.

Disinflation vs. Deflation

People often confuse disinflation and deflation. Deflation refers to drops in prices while disinflation refers to slowing inflation. Think of how an elevator goes up and down. Inflation is when an elevator rises, deflation is when it falls. Disinflation is when an elevator rises but at a slower pace than before.

Causes of Disinflation

The causes of disinflation are less clear than inflation or deflation, and they often occur at an industry level. However, here are a few reasons why this occurs.

• Economic stability: The COVID-19 pandemic destabilized countless markets. In 2024, inflation slowed due to global growth post-pandemic.
• Stronger supply chains: In the wake of the pandemic, many companies worked to strengthen their supply chains. Trends like nearshoring make production more affordable and stable.

Disinflation can often be considered a correction after a major event. It can also be caused by governments actively trying to slow inflation.

Effects

Disinflation can have multiple effects on companies and individuals. Here are a few benefits, as reviewed by the St. Louis Federal Reserve Bank.

• Lower and fixed-income houses have more spending power: The overall cost of goods and services is lower.
• Spending increases: Concerns about inflation can decrease, making consumers feel better about spending.
• Companies can produce goods at affordable prices: Their supply chains are stable so production costs are lower.

Disinflation often benefits lower-income populations because they are most affected by inflation. Higher-income households can absorb the cost easier than those on tight budgets.

Examples

You can see multiple examples of disinflation following the COVID-19 pandemic. Used car prices skyrocketed during this time because automotive production came to a halt. Demand for used cars remained high through 2024, but prices began to stabilize to align closer with expected demand.

You can also see examples of disinflation in the housing market. Home prices shot up during the pandemic because owners weren’t selling. In 2024, more people entered the market, increasing the overall supply. This caused home prices to remain stable or even drop in some areas.

Management Strategies

Governments have multiple strategies to support consumers and businesses during periods of disinflation.

• Identify volatile industries: Governments might be able to address problems with specific industries that are affecting the national economy.
• Support employment: Keeping employment high is important in times of high inflation and deflation.
• Share messages of economic stability: Inflation expectations could cause people to raise prices, failing to slow price increases.

American perceptions of the economy have a significant impact on inflation, deflation, and disinflation. While certain trends can affect specific industries and have national ripple effects, consumer behavior is a significant economic driver.