Many people consider deflation and disinflation to be interchangeable terms since they both result in a decrease in the general price level, which reduces the money supply in the economy.
Nonetheless, these two concepts are distinct in that deflation refers to a fall in the price of goods and services, whereas disinflation refers to a gradual decline in the rate of inflation. Disinflation that lasts for a long time can lead to disinflation.
Deflation occurs when the inflation rate falls below 0%, or when the inflation rate is negative. Disinflation, on the other hand, is the slowing of the rate of inflation. Read this essay carefully to understand the key distinctions between deflation and disinflation.
What is Disinflation?
The most significant distinction between disinflation and deflation is that prices do not fall in the former. The Indian economy is still experiencing price increases, though at a slower pace. India is currently experiencing disinflation, which means that price increases have slowed significantly compared to the previous year.
Disinflation, unlike deflation, is regarded as a positive indicator, and capital markets, particularly bond markets, tend to react favourably to it. However, deflation without economic growth might be dangerous.
Economists have long believed that inflation is good for a rising economy. This means that when there is economic development, some price rise is unavoidable, and it indicates that the macros are in good shape.
If inflation slows rapidly without being supported by quicker GDP growth, it could lead to a halt in economic growth, which would be followed by declining productivity and growing unemployment.
Economists currently expect lower inflation or disinflation in India, along with better economic growth, which is a favourable position to be in.
What is Deflation?
This is when prices start to drop. While such a situation appears to be favourable, it is not one that any economy wants to be in. Deflation is frequently associated with a slowing economy, decreasing productivity, and job losses.
In the same way as inflation lowers the value of money, deflation raises it. This encourages people to save money in order to purchase items at a lower price later, reducing economic growth even more. Although the value of money rises and products become cheaper during deflation, you may end up earning less due to slower growth.
Deflation was severe during the Great Depression; it had reached double digits. For the past two decades, Japan has struggled with deflation. Shinzo Abe, Japan's Prime Minister, only recently declared that the country's deflationary phase has ended and that economic recovery is on the way.
(Speaking of Great Depression, you can sneak a peek at our blog on 3 Catastrophic Financial Crisis in Past)
Because most other economies are experiencing inflation, deflation has a favourable influence on export competitiveness. In the last decade or so, Japan has profited from competitive exports.
Deflation, unlike disinflation, is undesirable for obvious reasons. Bond markets, on the other hand, may do well even in times of deflation, as people seek protection in their investments.
Disinflation vs. Deflation: What's the Difference?
The distinction between deflation and disinflation can be clearly defined on the basis of the following factors:
Prices fall below the typical level in a deflation, as there is no limit to how far prices can fall. Disinflation, on the other hand, aids in bringing prices down to a reasonable level.
(Now that we mentioned Prices, check out Price Ceiling and Price Floor)
Watch this: Deflation Explained
Financial Markets, Deflation and Disinflation
For the financial markets, disinflation isn't always a bad thing. When the rate of inflation is falling, stocks can and often do well. In a disinflationary scenario, bonds are more likely to deliver above-average returns since central banks are less likely to raise interest rates and more likely to lower them.
Keep in mind that when inflation is strong, disinflation is a good thing. However, when the inflation rate approaches zero, markets will become increasingly concerned about disinflation and deflation becomes a possibility.
This distinction is due to the fact that deflation is a highly damaging condition for the economy and financial markets. Stock prices are expected to perform poorly during periods of deflation.
It isn't always caused by inflation; it can also be caused by the other factors that commonly accompany deflation (such as a severe recession, social unrest, etc).
Bonds, on the other hand, fare well in deflationary periods for a variety of reasons, including lower expectations for future inflation, favourable central bank policy, and a "flight to quality" into safer investments.
Furthermore, deflation allows lenders (i.e., bond buyers) to repay borrowers (i.e., bond issuers) with cash that has lost value over the bond's life.
Watch this: Inflation and Deflation
To comprehend the terms deflation and disinflation, one must first comprehend the definition of inflation, which is defined as a scenario in which the prices of an economy's output rise. Disinflation occurs when the pace of inflation decreases and continues until it reaches zero, but deflation occurs when the rate is less than zero.
The main distinction between these two is that deflation is caused by a decrease in the total price level, whereas disinflation is caused by a decrease in the inflation rate.