About Inflation and Deflation

Every year the price of items goes up and the value of our money goes down which. This means that the United states economy is on an economic trend of inflation. When a country goes through the opposite effect of their currency gaining value and their products costs less they are going through a deflationary phase. We will talk about the effects of these two terms on the economy. These will affect you in different ways depending on your personal financial situation.

Effects of Inflation and Deflation

Since this is for investors and traders, I wrote this from the perspective of an individual; however, inflation and deflation can harm or help whole economies. There are 3 groups of people that economist talk about when it comes to this subject. They are generalizations but help illustrate who and how individuals are affected by valuation changes in currency.

  • Debtors

    By debtor, I am referring to someone that has a lot of outstanding loans. In this situation inflation will help this group of people. In theory, inflation means the value of the currency is declining. For the person who has more debt than savings, it is a good thing that the currency is losing value which makes their outstanding loan less money. On average inflation is 3% a year according to most economist and financial experts. If you start out with a 1,000 loan and the currency is less valuable then you automatically owe less. After one year inflation would cause your loan to be worth $970 by this logic.

  • Fixed Income

    Inflation is bad for individuals on Fixed income which are normally people who are retired that don’t get the cost of living increases of some working individuals. When your currency decreases in value the cost of goods increases.

  • Savers

    This is another group of people that are hurt by inflation. This is why it is bad to only have a savings account instead of doing investing. With the value of a currency decreasing by 3%, that means your saving would need to pay you at least 3% per year to keep up with inflation. That is why professionals in finance recommend that you invest your savings into something that pays 3% or more in interest per year.

Hyperinflation

Hyperinflation isn’t good for any group of people. This is referring to out of control inflation in a short period of time.  This normally happens during extreme economic circumstances such as war, natural disasters, or extreme recessions. The main cause of hyperinflation is a countries citizens losing faith in the stability of their own currency. This happened during the great depression in the united states which caused people to buy commodities such as gold. What happens is this creates an oversupply of the currency which makes it worth even less money. This happened in the post WW2 area in countries like Germany.

More Pages on Macroeconomics