What is the Difference Between Inflation, Deflation, and Disinflation?
Read Time: 5 Minutes
Author: James Tierney
Introduction
The price level is one key economic indicator introduced within the first few weeks of a macroeconomics class. The price level is the average level of prices in an economy. There are many ways of measuring the price level in the US including the Consumer Price Index (CPI), the Producer Price Index (PPI), the Personal Consumption Expenditures Price Index (PCE), and the GDP Deflator. All of these price indexes attempt to measure the average level of prices in the US. A few years back, I created a YouTube video to explain the main difference between the CPI and GDP Deflator.
Importance of Price Indexes
Price indexes are important because they inform policymakers on how prices change over time. Are goods and services becoming more expensive, therefore, taking up a larger share of consumers’ incomes? Are goods and services becoming less expensive making consumers delay spending on large purchases? Are these changes predictable allowing households and firms to plan decades into the future? These questions help policymakers understand the economic environment and make better-informed decisions. Understanding prices and how they affect the economy is very important in a macroeconomics class — your first step towards becoming the next generation of policymakers. But before we, as educators, can get to these deeper questions surrounding effective policy, we need our students to understand the vocabulary.
What is inflation?
Students, more often than not, are quick to learn the definitions of inflation and deflation. Deeper understandings (for example, who benefits and is harmed from each) may not be as intuitive. Inflation is when price levels are rising, and deflation is when price levels are falling. An easy way to see this is by viewing a graph of the inflation rate. The inflation/deflation rate is found by calculating the year-over-year percentage change in a price level. Here is an old YouTube video showing the percentage change in CPI.
Therefore, inflation occurs when the percentage change from a year ago in a price level is positive, and deflation occurs when that change is negative. If looking at a graph of the percentage change from a year ago in a price level, those areas are easily defined by data points above and below 0:
While students well know inflation and deflation even before entering their first economics class, disinflation is a different story. Many students have not heard of the term so popular in the early 1980s.
What is Disinflation?
Disinflation is when we see a reduction in, or a slowing of, the inflation rate. In other words, the price level is increasing but at a decreasing rate. The most famous period of disinflation in US history, regularly referred to as Volcker Disinflation named after the Federal Reserve Chairman during this time, occurred in the early 1980s. As shown below, inflation peaked at over 14.5% in March 1980, before continually falling for the next 3 years:
In short, understanding how prices affect the economy starts with the vocab used in policy circles. Being able to define and identify the differences between inflation, deflation, and disinflation is something I make sure to assess students on each semester. Here is a common question:
