- Consumers anticipate reduced prices in the future as a result of deflation expectations. As a result, demand falls and growth decreases.
- Because interest rates can only be decreased to zero, deflation is worse than inflation.
Isn’t deflation always preferable to inflation?
1. Deflation (price declines negative inflation) is extremely dangerous. People are hesitant to spend money while prices are falling because they believe items will be cheaper in the future; as a result, they continue to postpone purchases. Furthermore, deflation raises the real worth of debt and lowers the disposable income of people who are trying to pay off debt. When consumers take on debt, such as a mortgage, they typically expect a 2% inflation rate to help erode the debt’s value over time. If the 2% inflation rate does not materialize, their debt burden will be higher than anticipated. Deflationary periods wreaked havoc on the UK in the 1920s, Japan in the 1990s and 2000s, and the Eurozone in the 2010s.
2. Wage adjustments are possible due to moderate inflation. A moderate pace of inflation, it is thought, makes relative salary adjustments easier. It may be difficult, for example, to reduce nominal wages (workers resent and resist a nominal wage cut). However, if average wages are growing due to modest inflation, it is simpler to raise the pay of productive workers; unproductive people’ earnings can be frozen, effectively resulting in a real wage reduction. If there was no inflation, there would be greater real wage unemployment, as businesses would be unable to decrease pay to recruit workers.
3. Inflation allows comparable pricing to be adjusted. Moderate inflation, like the previous argument, makes it easier to alter relative pricing. This is especially significant in the case of a single currency, such as the Eurozone. Countries in southern Europe, such as Italy, Spain, and Greece, have become uncompetitive, resulting in a high current account deficit. Because Spain and Greece are unable to weaken their currencies in the Single Currency, they must reduce comparable prices in order to recover competitiveness. Because of Europe’s low inflation, they are forced to slash prices and wages, resulting in decreased growth (due to the effects of deflation). It would be easier for southern Europe to adjust and restore competitiveness without succumbing to deflation if the Eurozone had modest inflation.
4. Inflation can help the economy grow. The economy may be locked in a recession during periods of exceptionally low inflation. Targeting a higher rate of inflation may theoretically improve economic growth. This viewpoint is divisive. Some economists oppose aiming for a higher inflation rate. Some, on the other hand, would aim for more inflation if the economy remained in a prolonged slump. See also: Inflation rate that is optimal.
For example, in 2013-14, the Eurozone experienced a relatively low inflation rate, which was accompanied by very slow economic development and high unemployment. We may have witnessed a rise in Eurozone GDP if the ECB had been willing to aim higher inflation.
The Phillips Curve argues that inflation and unemployment are mutually exclusive. Higher inflation reduces unemployment (at least in the short term), but the significance of this trade-off is debatable.
5. Deflation is preferable to inflation. Economists joke that the only thing worse than inflation is deflation. A drop in prices can increase actual debt burdens while also discouraging spending and investment. The Great Depression of the 1930s was exacerbated by deflation.
Disadvantages of inflation
When the inflation rate exceeds 2%, it is usually considered a problem. The more inflation there is, the more serious the matter becomes. Hyperinflation can wipe out people’s savings and produce considerable instability in severe cases, such as in Germany in the 1920s, Hungary in the 1940s, and Zimbabwe in the 2000s. This type of hyperinflation, on the other hand, is uncommon in today’s economy. Inflation is usually accompanied by increased interest rates, so savers don’t lose their money. Inflation, on the other hand, can still be an issue.
- Inflationary expansion is often unsustainable, resulting in harmful boom-bust economic cycles. For example, in the late 1980s, the United Kingdom experienced substantial inflation, but this economic boom was unsustainable, and attempts by the government to curb inflation resulted in the recession of 1990-92.
- Inflation tends to inhibit long-term economic growth and investment. This is due to the increased likelihood of uncertainty and misunderstanding during periods of high inflation. Low inflation is said to promote better stability and encourage businesses to invest and take risks.
- Inflation can make a business unprofitable. A significantly greater rate of inflation in Italy, for example, can render Italian exports uncompetitive, resulting in a lower AD, a current account deficit, and slower economic growth. This is especially crucial for Euro-zone countries, as they are unable to devalue in order to regain competitiveness.
- Reduce the worth of your savings. Money loses its worth as a result of inflation. If inflation is higher than interest rates, savers will be worse off. Inflationary pressures can cause income redistribution in society. The elderly are frequently the ones that suffer the most from inflation. This is especially true when inflation is strong and interest rates are low.
- Menu costs – during periods of strong inflation, the cost of revising price lists increases. With modern technologies, this isn’t as important.
- Real wages are falling. In some cases, significant inflation might result in a decrease in real earnings. Real incomes decline when inflation is higher than nominal salaries. During the Great Recession of 2008-16, this was a concern, as prices rose faster than incomes.
Inflation (CPI) outpaced pay growth from 2008 to 2014, resulting in a drop in living standards, particularly for low-paid, zero-hour contract workers.
Why is deflation undesirable?
Deflation is usually an indication of a deteriorating economy. Deflation is feared by economists because it leads to lower consumer spending, which is a key component of economic growth. Companies respond to lower pricing by decreasing production, which results in layoffs and compensation cuts.
Who is the hardest hit by inflation?
Inflation is defined as a steady increase in the price level. Inflation means that money loses its purchasing power and can buy fewer products than before.
- Inflation will assist people with huge debts, making it simpler to repay their debts as prices rise.
Losers from inflation
Savers. Historically, savers have lost money due to inflation. When prices rise, money loses its worth, and savings lose their true value. People who had saved their entire lives, for example, could have the value of their savings wiped out during periods of hyperinflation since their savings became effectively useless at higher prices.
Inflation and Savings
This graph depicts a US Dollar’s purchasing power. The worth of a dollar decreases during periods of increased inflation, such as 1945-46 and the mid-1970s. Between 1940 and 1982, the value of one dollar plummeted by 85 percent, from 700 to 100.
- If a saver can earn an interest rate higher than the rate of inflation, they will be protected against inflation. If, for example, inflation is 5% and banks offer a 7% interest rate, those who save in a bank will nevertheless see a real increase in the value of their funds.
If we have both high inflation and low interest rates, savers are far more likely to lose money. In the aftermath of the 2008 credit crisis, for example, inflation soared to 5% (owing to cost-push reasons), while interest rates were slashed to 0.5 percent. As a result, savers lost money at this time.
Workers with fixed-wage contracts are another group that could be harmed by inflation. Assume that workers’ wages are frozen and that inflation is 5%. It means their salaries will buy 5% less at the end of the year than they did at the beginning.
CPI inflation was higher than nominal wage increases from 2008 to 2014, resulting in a real wage drop.
Despite the fact that inflation was modest (by UK historical norms), many workers saw their real pay decline.
- Workers in non-unionized jobs may be particularly harmed by inflation since they have less negotiating leverage to seek higher nominal salaries to keep up with growing inflation.
- Those who are close to poverty will be harmed the most during this era of negative real wages. Higher-income people will be able to absorb a drop in real wages. Even a small increase in pricing might make purchasing products and services more challenging. Food banks were used more frequently in the UK from 2009 to 2017.
- Inflation in the UK was over 20% in the 1970s, yet salaries climbed to keep up with growing inflation, thus workers continued to see real wage increases. In fact, in the 1970s, growing salaries were a source of inflation.
Inflationary pressures may prompt the government or central bank to raise interest rates. A higher borrowing rate will result as a result of this. As a result, homeowners with variable mortgage rates may notice considerable increases in their monthly payments.
The UK underwent an economic boom in the late 1980s, with high growth but close to 10% inflation; as a result of the overheating economy, the government hiked interest rates. This resulted in a sharp increase in mortgage rates, which was generally unanticipated. Many homeowners were unable to afford increasing mortgage payments and hence defaulted on their obligations.
Indirectly, rising inflation in the 1980s increased mortgage payments, causing many people to lose their homes.
- Higher inflation, on the other hand, does not always imply higher interest rates. There was cost-push inflation following the 2008 recession, but the Bank of England did not raise interest rates (they felt inflation would be temporary). As a result, mortgage holders witnessed lower variable rates and lower mortgage payments as a percentage of income.
Inflation that is both high and fluctuating generates anxiety for consumers, banks, and businesses. There is a reluctance to invest, which could result in poorer economic growth and fewer job opportunities. As a result, increased inflation is linked to a decline in economic prospects over time.
If UK inflation is higher than that of our competitors, UK goods would become less competitive, and exporters will see a drop in demand and find it difficult to sell their products.
Winners from inflation
Inflationary pressures might make it easier to repay outstanding debt. Businesses will be able to raise consumer prices and utilize the additional cash to pay off debts.
- However, if a bank borrowed money from a bank at a variable mortgage rate. If inflation rises and the bank raises interest rates, the cost of debt repayments will climb.
Inflation can make it easier for the government to pay off its debt in real terms (public debt as a percent of GDP)
This is especially true if inflation exceeds expectations. Because markets predicted low inflation in the 1960s, the government was able to sell government bonds at cheap interest rates. Inflation was higher than projected in the 1970s and higher than the yield on a government bond. As a result, bondholders experienced a decrease in the real value of their bonds, while the government saw a reduction in the real value of its debt.
In the 1970s, unexpected inflation (due to an oil price shock) aided in the reduction of government debt burdens in a number of countries, including the United States.
The nominal value of government debt increased between 1945 and 1991, although inflation and economic growth caused the national debt to shrink as a percentage of GDP.
Those with savings may notice a quick drop in the real worth of their savings during a period of hyperinflation. Those who own actual assets, on the other hand, are usually safe. Land, factories, and machines, for example, will keep their value.
During instances of hyperinflation, demand for assets such as gold and silver often increases. Because gold cannot be printed, it cannot be subjected to the same inflationary forces as paper money.
However, it is important to remember that purchasing gold during a period of inflation does not ensure an increase in real value. This is due to the fact that the price of gold is susceptible to speculative pressures. The price of gold, for example, peaked in 1980 and then plummeted.
Holding gold, on the other hand, is a method to secure genuine wealth in a way that money cannot.
Bank profit margins tend to expand during periods of negative real interest rates. Lending rates are greater than saving rates, with base rates near zero and very low savings rates.
Anecdotal evidence
Germany’s inflation rate reached astronomical levels between 1922 and 1924, making it a good illustration of high inflation.
Middle-class workers who had put a lifetime’s earnings into their pension fund discovered that it was useless in 1924. One middle-class clerk cashed his retirement fund and used money to buy a cup of coffee after working for 40 years.
Fear, uncertainty, and bewilderment arose as a result of the hyperinflation. People reacted by attempting to purchase anything physical such as buttons or cloth that might carry more worth than money.
However, not everyone was affected in the same way. Farmers fared handsomely as food prices continued to increase. Due to inflation, which reduced the real worth of debt, businesses that had borrowed huge sums realized that their debts had practically vanished. These companies could take over companies that had gone out of business due to inflationary costs.
Inflation this high can cause enormous resentment since it appears to be an unfair means to allocate wealth from savers to borrowers.
Inflation and deflation benefit who?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
Are deflation and inflation synonymous?
Inflation is defined as an increase in the overall cost of goods and services in a given economy. Deflation, on the other hand, is defined as a general decrease in the price of goods and services, as measured by an inflation rate below zero percent.
Who gains from deflation?
- Consumers benefit from deflation in the near term because it enhances their purchasing power, allowing them to save more money as their income rises in relation to their expenses.
- In the long run, deflation leads to greater unemployment rates and can lead to consumers defaulting on their debt obligations.
- The last time the world was engulfed in a long-term phase of deflation was during the Great Depression.
Who suffers from deflation?
Exacerbating deflation can send an economy into a deflationary spiral. This occurs when price reductions lead to reduced production levels, which in turn leads to lower wages, which in turn leads to lower demand from businesses and consumers, resulting in more price reductions. Education and healthcare are two areas of the economy that have historically been well-insulated from economic downturns, as their expenses and prices may actually rise while the overall level of pricing for most products and services falls.
Has the United States ever experienced deflation?
- The opposite of inflation, which occurs when the cost of goods and services rises, is deflation, which is a reduction in the general price level of goods and services.
- Deflation can be produced by a variety of economic variables, including a decline in product demand, an increase in product supply, surplus production capacity, an increase in money demand, or a decrease in money supply or credit availability.
- During the Great Depression, between 1930 and 1933, the United States saw the most extreme deflationary phase in its history.
Does inflation make the wealthy even wealthier?
The rate at which prices grow is referred to as inflation. As a result, your dollar’s purchase power is dwindling, and it’s just getting worse “Over time, it has become “watered down.”
It’s why a pack of Wrigley’s gum that cost 4 cents in 1913 now costs one dollar. US Inflation Calculator is the source of this information.
It’s possible that your net worth will increase next year. However, if your net worth increases at a slower rate than inflation, you will experience diminished prosperity.
You are not as concerned about inflation as you should be. One of the reasons is that you’ve never seen one before “Along with your utility bill, internet bill, credit card bill, and Netflix bill, you’ll have a “inflation bill.”
This steady and unavoidable depreciation of the dollar is exactly why you wouldn’t store a million dollars in the bank for three decades.
What a load of nonsense! A 4% inflation rate will reduce your million dollars’ purchasing power to just $308,000 in thirty years.
Inflation is the reason why today’s millionaires will be poor tomorrow. Do you think that’s ridiculous? It’s a foregone conclusion.
Inflation has already shifted the burden “From wealthy to middle class, the term “millionaire” is used. Many people thought that was impossible.
Governments and central banks have fed their inflationary mission since the Ancient Romans coarsely clipped the edge of denarius coins through the United States Federal Reserve’s Quantitative Easing in the 2000s. They also have a strong incentive to conceal the true pace of inflation. They’re two different conversations.
The majority of real estate investors are unaware of all the different ways they might be compensated. Furthermore, most real estate investment educators are unaware of all the different ways real estate investors get compensated!
For real estate investors, inflation benefitting is simply one of at least five simultaneous wealth centers. We can borrow with long-term fixed-rate debt while tying debt to a cash-flowing asset.
Your monthly debt payments are totally outsourced to tenants when you borrow this manner.
Why rush to pay off your loan when your debt burden is eroded by both tenants and inflation?
Instead of paying down debt, you may use a dollar to buy more real estate or improve your lifestyle.
You wouldn’t retain a million dollars in the bank since it would erode your purchasing power. When you borrow a million dollars, however, inflation reduces the value of your debt.
With a 4% annual inflation rate, your million-dollar debt will be reduced to only $308,000 in thirty years.
So, if you take out a million dollar loan and assume 10% inflation over a number of years, you’ll only have to repay a million dollars in nominal terms. The term “nominal” refers to something that isn’t “Only in name.”
With the passage of time, an expanding currency supply means that wages will rise, consumer prices will rise, and your rent will rise. As a result, repaying this form of debt is becoming increasingly simple.
As a real estate investor, inflation-profiting may be your quietest wealth center. It’s a unique situation “I’m a friendly phantom.”
Your $1,250 fixed-rate monthly mortgage payment, for example, will not grow with inflation. Your rent income, on the other hand, has done so in the past. This also adds to your monthly cash flow in a non-obtrusive way.
If you don’t have a loan on the property, you won’t be able to take advantage of these inflation-bearing benefits.
Inflation is a process by which money is transferred from lenders to borrowers. Lenders are compensated in diluted dollars.
Inflation also redistributes income from the elderly to the younger generations. Why? Because the elder generation has more assets and the younger generation has more debt.
I’m going to carry a lot of debt even when I’m older since I understand how inflation favours long-term fixed-rate debtors. Real estate investors are in the best position to profit from this.
Globalization and technological advancements may help to lower the rate of inflation. But I don’t think it’ll be able to reverse it.
I’ve had millions of dollars in debt since I was a child. Then I’m going for debt in the hundreds of millions of dollars.
Importantly, each debt is cleverly tethered to an asset a house that is worth more than the debt amount.
It’s property that generates cash flow and is located in an area with a variety of economic sectors. As a result, I am certain that employment growth will continue to boost rent incomes. These earnings pay off the debt and even offer a cash flow stream for me.
I’m not concerned if the asset’s value dips temporarily, like it did in 2007-2009, as long as it continues to generate income.
Not only am I hedging inflation with this prudent debt, but it also allows me to leverage financial leverage to increase appreciation while also providing considerable tax benefits.
Because your first encounter with debt was when it was related to something that didn’t provide money, debt has a poor reputation.
To make your Honda payment, you were obliged to work overtime on the weekend. You made sacrifices in order to pay credit card finance costs on a six-month-old Morton’s Steakhouse supper.
Unlike real estate, you didn’t have to worry about your debt being paid off by renters and inflation, and you had a steady stream of income.
You’re no longer trapped beneath debt when you use smart debt tied to an income-producing single-family home or eight-plex.
Borrow a lot of money. You’ll only have what the crowd has if you do what the crowd does.
Make the most of loans and leverage. Across my portfolio, I maximize loan amounts. The basic vanilla 30-year fixed amortizing loan is my personal preference.
I hold minor equity positions in several income properties rather than significant equity positions in a handful as a 15-year active real estate investor. My principal residence, which my wife and I own, is even heavily mortgaged.
Take a look at what I’ve done. Allowing equity (a zero-ROI element) to build uncontrollably in any one property is a risk and opportunity expense I realize. With cash-out refinances and 1031 tax-deferred exchanges, my money velocity remains strong.
Some real estate enthusiasts waste their time your most valuable and irreplaceable resource flipping, wholesaling, or managing their own properties.
Why toil when you may enjoy life? I have a team of workers ready to help. “Tenants,” “Leverage,” and “Leverage” are their names “They’re called “inflation,” and they do my work for me. Keep an eye on the clock.
Your currency will continue to depreciate. Rather of being a source of aggravation, you now know how to use it to your advantage.
This is why I’m a proponent of inflation. When Apple products or Starbucks drinks see another retail price increase, I feel validated!
Some folks can’t sleep because they have so much terrible debt. I couldn’t sleep if I didn’t have enough smart debt.
Have you ever considered putting your money to work for you? That’s not the case! That is a fallacy. 7 Money Myths That Are Killing Your Wealth Potential, my free wealth-building E-book, is now completely free. For a limited time, get it here.