While the Federal Reserve toys with the idea of using monetary policy in an effort to stave off another recession, we commoners are left wondering what our fates may be in the coming months and years.
One word in particular has been uttered by the lips of many different economists, journalists, and pundits: inflation. The various permutations of the word that can follow its utterance include: deflation, disinflation, and hyper-inflation (among others).
I thought it would be appropriate to give a bit of insight into what these different terms actually mean and provide scenarios when they have or could have occurred, in hopes of taking a bit of the hot air out of the inflation conversation:
When the prices of goods and services rises slowly and at a steady predictable rate (let’s say 2 or 3 percent of current prices), this is normal, run-of-the-mill inflation. Economies generally enjoy this type of steady, predictable increase in prices. The U.S. experienced even, sensible inflation through the economic growth period we called the early 1990s.
Deflation is the opposite of inflation: prices decreasing relative to where they were previously. This is scary for businesses because it generally means their revenue may decrease, impacting profits, and dangerous for homeowners because their property values (which are stores of wealth) may decline as well.
While the U.S. was enjoying inflationary prosperity, Japan was moving in the opposite direction through the ’90s; their stock and real estate markets plummeted into what some economists dubbed Japan’s “Lost Decade.”
If prices are rising, but at a lesser rate than the previous period, this is referred to as disinflation. Disinflation can be good or bad for an economy depending on the circumstances: if a country’s economy is growing (read: inflating) at an unsustainable rate then disinflation can reign in the growth and return things to status quo; if an economy is already slow, disinflation can be the intermediate step between inflation and the deadly scenario of deflation.
Hyper-inflation is what it sounds like: extreme increases in prices, and is enabled by massive influxes of money into an economy. This is usually always a daunting scenario because of the relationship between wages and prices: as prices increase, wages increase to maintain a standard of living.
If wages increase, then costs for businesses increase, and businesses raise their prices to maintain profitability. And if prices are raised, then wages must be raised, and so on.
Eventually, enough money could be pushed into the system that money itself loses nearly all its value relative to other currencies. Germany experienced one of the worst cases of this in the 1920s, when prices were doubling every three to four days.
The real problem with talk of the near future is exactly that: it’s all talk. Not even our Federal Reserve Chairman knows what will happen (though he may be hoping for inflation).
Unpredictable times remind us of our philosophy: that the ability to react to what happens is more important than the ability to predict what may happen.
Joseph “Big Joe” Clark is a Certified Financial Planner and the Managing Partner of the Financial Enhancement Group, LLC.
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Clark: All the hot air about inflation
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