How To Deal With Inflation And Deflation

Compared to hunting and gathering society, when the concept of money was unknown, today’s world is a lot more complex. Inflation and deflation are two economic phenomena that dictate our lifestyle. Inflation refers to the state in which the prices of goods and services are rising and the value of money is decreasing, whereas deflation is the fall in the prices and increase in the value of money. These two economic cycles hold a significant influence over the life of people by making them adapt to their financial condition and understand their financial priorities.

There are many factors that we have to keep into consideration to understand the causes of inflation and deflation. Today, the population is steadily increasing. This in turn increases the demand for goods and services, as a result the prices rise to meet the increased demand, causing inflation. Similarly, the increase in salary, profit margin by producers, and prices of raw materials can directly influence the prices of goods and services by increasing the cost of production. Furthermore, the increase in the disposable income and money supply in the economy increase the purchasing power of individuals. Due to this, consumers demand more goods and services, leading to an increase in the price level in the economy.

On the other hand, deflation is the opposite of inflation. Deflation is caused when there is excess supply of goods and services over limited demand. This forces the suppliers to reduce the prices to increase sales. Additionally, the decrease in the cost of production (rent, wages, interest, and raw materials) encourages production, which increases the supply in the economy. Likewise, the decrease in money supply and salary reduces the purchasing power of the consumers, which reduces the demand. As a result, the producers are forced to reduce the prices, causing deflation.

 Impacts on lifestyle

Expecting a rise in the prices in the future, people spend their money either quickly or cautiously during inflation. People usually avoid buying non-essential and luxurious goods and opt for necessary goods to deal with increased prices. Basically, consumers may make huge necessary purchases to avoid higher prices later. On the other hand, in deflation, consumers tend to postpone their purchases as they are expecting the prices to drop further in the future. This decreases the overall demand in the economy, making businesses struggle due to reduced revenue.

As interest rates decrease, the traditional saving account becomes less viable for investment during the time of inflation. Due to this, people rather invest in stocks, real-estate, commodities, and inflation-protected securities. On the contrary, people like to hold on to their cash or keep their savings in low-risk avenues such as bank deposits in deflation as the value of money rises. This might seem advantageous for the savers, but it is harmful for the economy since it discourages investment.

 In inflation, people usually seek a salary increase to maintain their standard of living. The people with fixed income are at great risk as the value of money steadily declines. Conversely, people’s jobs are at risk during deflation. Companies might cut jobs to manage their reduced income or reduce the salary of their workers. The job market becomes more competitive during this time.

 Costlier debt 

As the value of money decreases during inflation, it becomes difficult for middle-class members to maintain their lifestyle. Due to the increasing rate of interest, loans and debts become costlier in inflation. In contrast, deflation increases the real value of debts, making it difficult to repay them. As the income of people decreases and the loan obligation remains the same, people struggle with repaying loans during deflation.

The key to dealing with these economic shifts lies in adaptability and financial planning. During inflation, people should spend wisely by making large necessary purchases earlier before prices rise further. Taking fixed-rate loans and avoiding variable-rate loans should be put into consideration. Moreover, negotiating salary increases and developing multiple income streams can offer further help. In deflation, on the other hand, maintaining high cash reserves, prioritising debt repayment, avoiding new debt, developing personal skills to remain competitive in the job market, and being prepared for wage reductions can safeguard one’s standard of living. 

(Maharjan is an economics student.)