Inflation is the process whereby ‘things’ – balloons, tyres, opinions, etc. – wbecome enlarged. Deflation is the reverse process. In economics, inflation generally refers to money; or to money prices. Deflation, however, more often refers to falling output; that is, to a decline in productive activity, usually accompanied by a rise in unemployment. By these definitions inflation and deflation are likely to occur simultaneously.
Prices rise in consequence of spending triggered by new money; but if money wages and salaries remain unchanged (or rise by a lesser amount), real incomes fall. Although this might look like deflation, those features may be part of a lagged readjustment, with wages and salaries eventually catching up with prices (an inflationary ‘price-wage spiral’).
Careful exposition and precise terminology is always desirable. Confusion would be lessened if (monetary) inflation were defined ascurrency debasement. By that definition, rising prices might be indicative of inflation; but not always. The (obvious) exception is when prices (or, more to the point, price indexes) rise for reasons other than currency debasement. Recent commentary on the ‘Arab spring’ illustrates the potential for confusion:
‘Traders argue that if another domino falls, and many mention the Opec member Algeria, then the oil price would immediately leap dramatically. Global inflation ... would surge again. Living standards in Britain ... would take another punishing hit.’ (Sam Fleming, The Times, 5th March)
While a surging oil price would cause most, if not all, published price indices to rise, the impact (on output and employment) would be deflationary. Yet, as rising oil prices raise the cost of commodities for which oil is a necessary input, incentives are created for producers to economise in the use of oil, and for consumers to switch their spending away from the most heavily oil-based commodities. Although these must check both the demand for oil and the rise in prices, it is nevertheless likely that the purchasing power of money would fall. Yet, the fundamental cause would not have been currency debasement.
In such circumstances it would be inappropriate for the authorities to attempt to forestall market readjustments, either by easing credit or by greater deficit spending. As the current ‘oil shock’ incites calls for ‘politicians and central bankers’ to ‘make monetary policy even more stimulative to sustain growth and employment’ (Anatole Kaletsky, The Times, 9th March 2011), it might be noted that this strategy was engaged to offset the deflationary impact of the oil price rise of 1973; and that it led to inflationpeaking at over 24% in the UK in 1975.
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