Depending on whether the general price level is increasing, decreasing and to what extent and whether the inflation rate is decelerating, there are different states of an economy: inflation, deflation, hyperinflation and disinflation.

Inflation erodes purchasing power, but deflation increases it. However, it is not that inflation is bad and deflation is good.

Inflation

Inflation refers to a sustained rise in the price level. It is generally procyclical, i.e. it increases in expansions and decreases in recessions.

The inflation rate is determined as a percentage change in some index. It is important not only because it measures the erosion of purchasing power, but it might trigger a contractionary monetary policy action that may depress asset prices. If an economy is in stagflation, it is typically left to adjust on its own because no policy action is appropriate.

Deflation

Deflation represents a sustained decrease in the price level, i.e. negative inflation. Deflation causes an increase in the value of money and a decrease in the price level. This causes a decrease in revenues. But since many debt contracts and employment contracts are based on nominal values, most of the firm’s costs do not change in nominal terms. This forces companies to cut spending and induces a recession. This is why economists, prefer an inflation rate of 2%, well above the deflationary range.

Hyperinflation

Hyperinflation refers to extremely fast inflation. This often occurs when governments print an unsustainable level of currency to meet ballooning fiscal deficits. It also occurs when there is an excessive shortage of supply post-war, prolonged economic distress, etc.

Disinflation

Disinflation refers to a decrease in the magnitude of the inflation rate.

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