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Inflation and Deflation

Inflation and deflation are important economic phenomena that have negative consequences for the economy. Basically, inflation is defined as a general, or broadly-based, increase in the prices of goods and services over an extended period which consequently [H1] leads to a decline [H2] in the value of money and thus its purchasing power[H3].

Deflation is often defined as the opposite of inflation, namely as a situation in which the overall price level falls over an extended period.

When there is no inflation or deflation, we can say that there is price stability if, on average, prices neither increase nor decrease but stay stable over time. If, for instance, EUR 100 can buy the same basket of goods as it could, say one and two years ago, then this can be called a situation of absolute price stability.

Movements [H4] in individual prices and in the general price level

It is important to make a distinction [H5] between movements in prices of any individual good or service and movements in the general price level. Frequent changes in individual prices are quite normal in market-based economies, even if there is price stability overall. The changes in supply and / or demand conditions of individual goods or services inevitably [H6] lead to changes in their price. For example, in recent years we have seen substantial [H7] declines in the prices of computers and mobile phones, mainly resulting from rapid technological progress. However, from the beginning of 1999 to mid-2006, oil and other energy prices increased, partly as a result of concerns regarding the future supply of energy and partly as a result of increased demand for energy, in particular from fast-growing economies[H8]. On the whole, inflation in most industrialized countries remained low and stable – stability in the general price level can go hand-in-hand with substantial changes in individual prices as long as falling and rising prices offset [H9] each other so that the overall price level remains unchanged.

Measurement issues [H10]

How can inflation be measured? There are millions of individual prices in an economy. These prices are subject to continuous moves which basically reflect changes in the supply of and the demand for individual goods and services and thus give an indication of the “relative scarcity” of the respective goods and services. It is obvious that it is neither feasible [H11] nor desirable [H12] to take all of these prices into account, but neither is it appropriate to look at just a few of them, since they may not be representative of the general price level.