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Disinflation is a decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time. It is the opposite of reflation. Disinflation occurs when the increase in the “consumer price level” slows down from the previous period when the prices were rising.
In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.
A price index is a normalized average of price relatives for a given class of goods or services in a given region, during a given interval of time. It is a statistic designed to help to compare how these price relatives, taken as a whole, differ between time periods or geographical locations.
Gross domestic products (GDP) is a monetary measure of the market value of all the final goods and services produced in a specific time period, often annually. GDP (nominal) per capita does not, however, reflect differences in the cost of living and the inflation rates of the countries; therefore using a basis of GDP per capita at purchasing power parity (PPP) is arguably more useful when comparing living standards between nations.
If the inflation rate is not very high to start with, disinflation can lead to deflation – decreases in the general price level of goods and services. For example, if the annual inflation rate for the month of January is 5% and it is 4% in the month of February, the prices disinflated by 1% but are still increasing at a 4% annual rate. Again if the current rate is 1% and it is -2% for the following month, prices disinflated by 3% i.e. [1%-(-2)%] and are decreasing at a 2% annual rate.
In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.
There is widespread consensus among economists that inflation is caused by increases in the supply of money available for use in a nation's economy. Inflation can also occur when the economy 'overheats' because of excess aggregate demand (this is called demand-pull inflation). The causes of disinflation are the opposite, either a decrease in the growth rate of the money supply, or a business cycle contraction (recession). If the central bank of a country enacts tighter monetary policy, that is to say, the government starts selling its securities, the supply of money in an economy is reduced. This contraction of the money supply is known as quantitative tightening. During a recession, competition among businesses for customers becomes more intense, and so retailers are no longer able to pass on higher prices along to their customers. The main reason is that when the central bank adopts tight monetary policy, it becomes expensive to access money, which reduces demand for goods and services in the economy. Even though demand for commodities falls, supply of commodities remains unaltered. Thus, prices fall over time, which leads to disinflation.In contrast, deflation occurs when prices are actually dropping.
Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to heterodox economics, which encompasses various schools or approaches that are only accepted by their proponents, but not by economists in general.
The money supply is the total value of money available in an economy at a point of time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. Each country’s central bank may use its own definitions of what constitutes money for its purposes.
In macroeconomics, Aggregate Demand (AD) or Domestic Final Demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amounts of goods and services that will be purchased at all possible price levels.
A growth rate of unemployment below the natural rate of growth leads to an increase in the rate of inflation. But a growth rate of unemployment above the natural rate of growth leads to a decrease in the rate of inflation, also known as disinflation. This happens because when people are jobless they have less money to spend, which indirectly implies a money supply reduction in an economy.
The best example for a disinflated economy is Japan. In 1990 Japan's output growth rate was 5.2%, unemployment rate was 2.1% and inflation rate was 2.4%. But in 1992 the output growth rate fell to 1.0%, unemployment rate rose to 2.2% and inflation rate decreased to 1.7%. In the year 2000 the output growth rate was 2.8%, unemployment rate was 4.7% and inflation rate was –1.6%.
|Year||Output Growth Rate %||Unemployment Rate %||Inflation Rate %|
If disinflation continues until the inflation rate is zero, the economy enters a deflationary period, with decreasing general prices on all goods and services produced. An example of this happened during the month of October 2008, when U.S. consumer prices fell (deflation) by 1.01% but the overall annual inflation rate simply decreased (disinflation) from an annual rate of 4.94% to 3.66%.So the distinction between deflation and disinflation at that point was simply one of which time period was referred to—the monthly basis or the annual basis. Over the year, prices were up 3.66% while over the month prices were down 1.01%.
Disinflation is reduction in the inflation rate. Prices are still rising during disinflation, but at a lower rate. The general price level still rises, but at a slower rate resulting in a lower rate of real value destruction in money and other monetary items.
Deflation is a sustained decrease in the general price level (negative inflation rate) resulting in a sustained increase in the real value of money and other monetary items. Money and other monetary items are worth more all the time during deflation as opposed to being worth less all the time during inflation. Deflation causes an increase in the real value of money and other monetary items.
The Phillips Curve shows that there is a negative relationship between inflation and unemployment.
The Phillips curve is a single-equation economic model, named after William Phillips, describing an inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy. Stated simply, decreased unemployment, in an economy will correlate with higher rates of wage rises. Phillips did not himself state there was any relationship between employment and inflation; this notion was a trivial deduction from his statistical findings. Samuelson and Solow made the connection explicit and subsequently Milton Friedman and Edmund Phelps put the theoretical structure in place. In so doing, Friedman was to successfully predict the imminent collapse of Phillips' a-theoretic correlation.
The relationship between the Phillips curve and disinflation can be written as Өt-Өt-1=-ἀ(ut-un).
Here Өt is the present year's rate of inflation, Өt-1 is the previous year's rate of inflation, ut is the actual rate of unemployment and un is the natural rate of unemployment. ἀ is the parameter that captures the effect of unemployment on the wage. The L.H.S (left hand side) of the equation is the change in the inflation rate. The above equation explains that the change in the rate of inflation depends upon the difference between the actual rate of unemployment and the natural rate of unemployment i.e., (ut-un). The rate of inflation would decrease when the actual rate of unemployment is higher than the natural rate of unemployment leading to Disinflation. The inflation rate would increase when natural unemployment rate is higher than the actual unemployment rate.
To decrease the rate of inflation, the left side of the equation must be negative and the term (ut-un) must be positive. Mathematically:
ut > un = Disinflation ut < un = High Inflation
Though a decrease in the rate of inflation and the unemployment growth rate are related to each other, the relationship does not depend on the speed of disinflation. Simply speaking, the rate of inflation can be slowed by increasing the rate of unemployment at a smaller rate spread over many years—or disinflation can be achieved quickly by increasing the rate of unemployment at a higher rate spread over a few years. When we sum the rate of unemployment over the years, it is same.
This phenomenon can be explained with the help of point-year of excess unemployment.It is the difference between the actual and the natural rate of unemployment of one percentage point for one year. For example, suppose the natural rate of unemployment is 9%; an unemployment rate of 15% for 5 years in a row corresponds to five times (15-9 = 6; 5*6 = 30) point years of excess unemployment. Suppose the central bank wants to reduce inflation from 15% to 10% so that inflation rate equals to 5% and that too within a period of 1 year. The equation Өt-Өt-1=-ἀ(ut-un). states that to reduce the inflation rate to 5% requires one year of unemployment at 10% above the natural rate. The R.H.S equals to –5% and the inflation rate decreases by 10% within a year. Following this phenomenon to reduce inflation over 5 years requires 5 years of unemployment at 1%i.e.(10/5) above the natural rate, and so on. We can note that in the above phenomenon the number of point-years of excess unemployment required to decrease inflation is the same i.e. 5%.
A cost is always involved in reducing inflation. This is explained with the help of a sacrifice ratio. The sacrifice ratio is the amount of cost required to reduce the rate of inflation over time. It is the ratio of the aggregate percentage loss of GDP to the decrease in inflation. For example, suppose the central bank wants to reduce the inflation rate from 20% to 12% over a period of 4 years. To achieve this rate, suppose the economy must bear the cost of an output level 12% below plausible in the first year, 9% below the plausible in the second year, 6% below plausible in the third year, and 5% below plausible in the fourth year. Thus the total loss of GDP is 32% (12%+9%+6%+5%) and the decrease in inflation rate is 8%. Thus the sacrifice ratio is 4 (32/8).
To reduce inflation, policymakers must choose between cold-turkey and gradualist policies. Cold-Turkey policies try to reduce the inflation rate as quickly as possible towards a target. Gradualist policies reduce the rate of inflation at a slow pace, which is to say that these policies move the economy slowly towards a target.
Cold-turkey policies create a shock-effect, which might not be good for the economy if the shock is great, but can be good for the economy if it builds policymaker trustworthiness. Gradualist policies allow policymakers to incorporate new information when playing out the policies.
The Lucas critique states that it is improbable to assume that wage setters would not consider changes in policy when forming their expectation. If wage setters believe that policymakers are committed to decreasing the inflation rate, they lower their expectations of inflation, and this leads to a decline in the rate of actual inflation without the need for prolonged recession. This can be explained with the help of the above-mentioned equation, in which expected inflation is taken on the right: Өt=Өte-ἀ(ut-un). If the wage-setters look at the previous year's inflation rate and form their expectations accordingly, then inflation rate can be reduced only by accepting a higher rate of unemployment for some period. If Өte=Өt-1, from Өt-Өt-1=-ἀ(ut-un. Thus, to achieve: Өt < Өt-1, it must be that ut > un) If, however, wage-setters expect the rate of inflation to fall from 9% to 5%—i.e., it will indeed be lower than the past—then inflation would fall to 5% even if unemployment remains at the natural rate of unemployment.
One of the most important constituents of successful disinflation is the credibility of monetary policy according to Thomas J. Sargent. It states that the beliefs of wage setters are affected if they feel that the central bank are religiously committed in reducing the rate of inflation. The way the wage-setters formed their expectations can only be changed with the help of credibility. The credibility view is that fast disinflation is likely to be more credible than slow disinflation. Credibility decreases the unemployment cost of disinflation. Therefore, the central bank should go for fast disinflation.
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.
In economics, stagflation, or recession-inflation, is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment
Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on national output in the short run and on price levels over longer periods. Monetarists assert that the objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy.
Full employment is a situation in which everyone who wants a job can have work hours they need on fair wages. Because people switch jobs, full employment involves a positive stable rate of unemployment. An economy with full employment might still have underemployment where part-time workers cannot find jobs appropriate to their skill level. In macroeconomics, full employment is sometimes defined as the level of employment at which there is no cyclical or deficient-demand unemployment.
New Keynesian economics is a school of contemporary macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.
In economics and political science, fiscal policy is the use of government revenue collection and expenditure (spending) to influence a country's economy. The use of government revenues and expenditures to influence macroeconomic variables developed as a result of the Great Depression, when the previous laissez-faire approach to economic management became discredited. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics indicated that government changes in the levels of taxation and government spending influences aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target the inflation and to increase employment. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilize the economy over the course of the business cycle.
Monetary policy is the policy adopted by the monetary authority of a country that controls either the interest rate payable on very short-term borrowing or the money supply, often targeting inflation or the interest rate to ensure price stability and general trust in the currency.
The natural rate of unemployment is the name that was given to a key concept in the study of economic activity. Milton Friedman and Edmund Phelps, tackling this 'human' problem in the 1960s, both received the Nobel Prize in economics for their work, and the development of the concept is cited as a main motivation behind the prize. A simplistic summary of the concept is: 'The natural rate of unemployment, when an economy is in a steady state of "full employment", is the proportion of the workforce who are unemployed'. Put another way, this concept clarifies that the economic term "full employment" does not mean "zero unemployment". It represents the hypothetical unemployment rate consistent with aggregate production being at the "long-run" level. This level is consistent with aggregate production in the absence of various temporary frictions such as incomplete price adjustment in labor and goods markets. The natural rate of unemployment therefore corresponds to the unemployment rate prevailing under a classical view of determination of activity.
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long-run.
Reflation is the act of stimulating the economy by increasing the money supply or by reducing taxes, seeking to bring the economy back up to the long-term trend, following a dip in the business cycle. It is the opposite of disinflation, which seeks to return the economy back down to the long-term trend.
The United States Gold Reserve Act of January 30, 1934 required that all gold and gold certificates held by the Federal Reserve be surrendered and vested in the sole title of the United States Department of the Treasury. It also prohibited the Treasury and financial institutions from redeeming dollars for gold, established the Exchange Stabilization Fund under control of the Treasury to control the dollar’s value without the assistance of the Federal Reserve, and authorized the president to establish the gold value of the dollar by proclamation.
NAIRU is an acronym for non-accelerating inflation rate of unemployment, and refers to a theoretical level of unemployment below which inflation would be expected to rise. It was first introduced as NIRU by Franco Modigliani and Lucas Papademos in 1975, as an improvement over the "natural rate of unemployment" concept, which was proposed earlier by Milton Friedman.
The Depression of 1920–21 was a sharp deflationary recession in the United States and other countries, beginning 14 months after the end of World War I. It lasted from January 1920 to July 1921. The extent of the deflation was not only large, but large relative to the accompanying decline in real product.
The Lost Decade or the Lost 10 Years was a period of economic stagnation in Japan following the Japanese asset price bubble's collapse in late 1991 and early 1992. The term originally referred to the years from 1991 to 2000, but recently the decade from 2001 to 2010 is often included so that the whole period is referred to as the Lost Score or the Lost 20 Years. Broadly impacting the entire Japanese economy, over the period of 1995 to 2007, GDP fell from $5.33 trillion to $4.36 trillion in nominal terms, real wages fell around 5%, while the country experienced a stagnant price level. While there is some debate on the extent and measurement of Japan's setbacks, the economic effect of the Lost Decade is well established and Japanese policymakers continue to grapple with its consequences.
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
Inflationism is a heterodox economic, fiscal, or monetary policy, that predicts that a substantial level of inflation is harmless, desirable or even advantageous. Similarly, inflationist economists advocate for an inflationist policy.
Monetary policy is the monitoring and control of money supply by a central bank, such as the Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in the Philippines. This is used by the government to be able to control inflation, and stabilize currency. Monetary Policy is considered to be one of the two ways that the government can influence the economy – the other one being Fiscal Policy. Monetary Policy is generally the process by which the central bank, or government controls the supply and availability of money, the cost of money, and the rate of interest.