Disinflation
What is Disinflation?
Disinflation is a fall in the rate of inflation while prices are still rising, so the price level keeps increasing but more slowly than before.
Disinflation occurs when the rate of inflation decreases over time, but prices are still rising. It is a situation where the inflation rate is slowing down, but not yet negative. Disinflation can be caused by various factors, including a decrease in aggregate demand, an increase in productivity, and a decrease in the money supply. Disinflation is often seen as a positive development, as it can help to reduce the cost of living and increase the purchasing power of consumers.
Disinflation: a worked example
Start a price index at 100.0. Inflation runs 6 percent in Year 1, 4 percent in Year 2, and 2 percent in Year 3, a clear disinflation. Trace the index rather than the rate. After Year 1 it stands at 100.0 times 1.06, or 106.0. After Year 2 it is 106.0 times 1.04, or 110.24. After Year 3 it is 110.24 times 1.02, or about 112.44. The cumulative price change is (112.44 minus 100.0) divided by 100.0, times 100, which is about 12.4 percent. The inflation rate fell by two thirds while the cost of the basket climbed more than 12 percent. A basket priced at $200 in the starting period would cost about $224.89 by the end. Disinflation slows the climb, it never reverses it.
The mistake students make with disinflation
Reading a chart where the inflation line drops from 6 percent to 2 percent, students write that prices fell. The line did fall, which is what makes the error tempting, but the line plots the rate of change, not the level. As long as the plotted rate stays above zero, the price index is still rising each period, just by smaller steps. Prices fall only when the rate crosses below zero, and that is deflation, a different term. Ask whether the rate went negative or merely got smaller.
Disinflation questions
How does disinflation appear on a Phillips curve?
Disinflation shows up as a move down and to the right along the short-run Phillips curve, because a lower inflation rate arrives with higher unemployment in the short run. If people then revise their inflation expectations downward and wage bargains follow, the short-run Phillips curve shifts inward, and the lower inflation rate can hold at the natural rate of unemployment. That temporary rise in unemployment during the adjustment is the cost of bringing an inflation rate down.
What causes disinflation?
Disinflation usually follows contractionary policy or an easing of the pressures that produced the original inflation. A central bank raising interest rates shifts aggregate demand left relative to its previous path, slowing price increases. Falling input costs, a rebound in productivity, or a drop in the inflation expectations built into wage contracts do the same thing from the supply side. Disinflation achieved by cooling demand normally comes with slower output growth during the adjustment.
What is the difference between disinflation and deflation?
Disinflation and deflation differ by the sign of the inflation rate. Disinflation keeps the rate positive but shrinking, so an index might go from 100 to 106 to 110, still climbing but by less each period. Deflation puts the rate below zero, so the index might go from 110 back to 108, meaning the average price actually dropped. Disinflation is usually the goal of a central bank fighting high inflation, while deflation is a condition central banks work to avoid.
Related terms
Common comparisons
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