The Value of Inflation and Deflation

olu-eletu-38649Recently there has been some discussion as to the impact of inflation and deflation. They sound like complex terms, but they simply refer to the way we price and re-price our wages and everything we consume over time.

Deflation can actually benefit your household budget. With Deflation you spend less to acquire the same goods and services. For example lets say that a jug of milk cost you $5.00 last week but there is deflation in the economy. This same jug of milk might cost only $4.50 this week because of the deflation. You got the same product but for less money, hanging on to more of your wealth. Deflation increases your Purchasing Power Parity, meaning you spend less to get more. For more information on purchasing power parity see http://www.investopedia.com/updates/purchasing-power-parity-ppp/.

Inflation, in contrast, means you have to pay more for the same product or service.  This happens because the central bank prints money to stimulate growth, higher prices, and an increase in wages. Governments also prefer to keep the economy in inflation because the fixed dollar amount of their debt obligations are paid back in the future with shrinking dollars. By printing more money, the money that we have is now worth less, in turn lowering the actual size of the government debt obligation relative to the amount of taxes they can raise on a percentage basis.

Deflation got a bad name during the 1930’s when wages and commodity prices were dramatically slashed. With limited safety nets, wide spread misery occurred for the average person. My Dad tells the story about the winter of 1935 when he fed a steer over winter for sale in the spring. The steer was shipped from Manitoba to Toronto for sale in the Toronto Stock Yards. By the time the calf got to Toronto the market price had dropped and was not enough to cover the shipping costs, so the shipping company sent my father a bill.

Today’s deflation is less obvious. Maybe exported inflation is a better term. When a company’s locally manufactured good or service is not price competitive, they simply lay off the workers and have the same product manufactured overseas at a cheaper cost. Just walk around a Wal-Mart or Canadian Tire and see how many products are manufactured overseas.

Deflation occurs during periods of slower growth when people spend less and investors hold more cash, lacking confidence in the economy. Without the confidence that markets are likely to continue to gain, stock investors tend to have an emotional response and move to cash and guaranteed income type investment vehicles. This provides an oversupply of interest seeking money, causing the interest rate to be bid lower and lower.

In summary, which is better for savers? 2% interest rate with 0% inflation or an 8% interest rate with a 6% inflation rate.

Weekly World Business Events

Moving into recent news from the business world, we see that recently the S&P hit an all time high of 2,480 last week. The S&P is an index of the largest 500 companies on the New York stock exchange based on market value. For those that don’t know what an index is, or would like further knowledge on indexes, check out the following article: http://www.investopedia.com/university/indexes/index1.asp.

Looking at another piece of news from this past week, the US government statistics division announced that the US GDP grew 2.6% in the 2nd quarter of 2017. Comparing that to the 1st quarter rate of 1.3%.

Photo by Olu Eletu on Unsplash

Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy.

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