Economy Josh on 02 Feb 2009 04:14 am
Inflation vs. Deflation: How Each Impacts Your Finances
Lately there has been a lot of debate about whether the United States will continue in deflation or if it will soon turn to massive inflation.
I’m sure most of us know that inflation means rising prices while deflation means falling prices, but beyond that they have a profound effect on our economy, both on a macro and micro level. While neither would ever be considered good, they have very different impacts on our finances.
Here is a more thorough look at each and how they effect us:
Inflation
Inflation is a sustained increase in the level of prices for goods and services. As the level of inflation rises, the value of your money decreases.
What inflation means to your finances- Inflation beyond the standard level is basically like taking a pay cut at your job. As inflation increases, your purchasing power decreases.
As a simple example, let’s look at pizza. If a pizza cost $10 before inflation and you made $100 a week, you could buy 10 pizzas a week if you wanted to. If during a period of inflation the cost of pizza rises to $20 and your wages do not increase, you can now only buy 5 pizzas a week.
On a micro level the only way to combat inflation is to increase your earnings. If the value of your dollar increases, you simply need to make more dollars to counteract this. Inflation is especially hard on your savings, as any money stashed in accounts with a lower interest rate than the level of inflation will immediately begin to lose value with no way to combat it.
On a macro level, inflation is a redistribution of wealth from the poor and midde classes to the upper classes.
One group that may benefit from inflation is those in serious debt. In times of sudden, rapid inflation debts essentially become interest free.
Deflation
Deflation is characterized by a sharp decline in the general level of prices for goods and services, often caused by a reduction in the supply of money or credit.
What deflation means to your finances- On the surface, deflation may not seem like such a bad thing. The idea of significantly lowered prices for goods and services might even seem like it would be good for your finances. But deflation is nasty on an economy.
The largest side effect of deflation is unemployment. As prices fall, business make less profits and are forced to cut employees and/or eventually go out of business. This is what happened during the great depression and this is what our country is seeing now as you can’t turn on the news without hearing about the lastest job losses.
On a micro level, deflation effects every social class equally. While inflation typically takes money from the poor and middle class and redisbributes it to the wealthy, deflation takes money from everyone equally. However, if you are financially responsible, have the money to buy, and are lucky enough to have job security, deflation is a great buyers market.
On a macro level, deflation is a disaster. It completely stalls the economy, creates historic levels of unemployment and can eventually to recessions into depressions.
Which One Should We Be Rooting For?
Obviously the real answer is that we don’t want either, but let’s assume you have to pick a horse in this race.
From a personal stand point, there could be reasons to root for deflation over inflation. As I said before, it can be a great time to buy, especially large items like cars and houses, for those that can afford to do so. But if you are concerned with the economy as a whole, inflation is much less damaging. And it is hard to argue that we are all better off when the economy is better off. Inflation is generally a sign of a growing economy while deflation is a sign of a stagnant one.
I’m not sure whether our immediate future holds more deflation or a shift to rapid inflation, but I do know that either way I’m going to keep paying off my debts and saving. Inflation and deflation are temporary phenominas. They come and go. Getting yourself in good financial shape is a move that can help you fight off both, or at least make the damages from them minimal.
Please continue sending any personal finance related questions, suggestions and tips to centsabilitytowealth@gmail.com.
Technorati Tags: inflation, deflation, economy, personal finance, unemployment, money
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