Economic inflation is when the economy experiences a decline in the prices of goods and services. In this regard, economic inflation is the opposite of inflation, where the costs of goods and services rise.
Definition and Examples of Economic Inflation
“Inflation” is an economic term that describes an environment of declining prices for goods and services within an economy. It should not be confused with mild inflation or a decrease in the inflation rate, where inflation occurs when the rate of inflation is below 0%.
The core consumer price index (CPI) is the most common means of measuring inflation. The CPI measures the prices of household goods and services in the economy. If the CPI reaches a negative number, this indicates the presence of negative inflation.
The United States has experienced several periods of inflation. For example, inflation occurred in 2009 due to the financial crisis and the Great Recession, with the consumer price index rate at -0.04%. During the Great Depression, inflation in the United States was much more severe and occurred over multiple years as illustrated below:
1930: -2.7%
1931: -8.9%
1932: -10.3%
1933: -5.2%
How Economic Inflation Works
Understanding the economics of inflation can make you a better investor. Inflation usually occurs during periods of recession, where the demand for most goods and services decreases, and providers of these goods and services lower prices to compete for fewer consumer dollars.
In severe cases, consumers postpone purchases in anticipation of further price declines. This often leads to a self-fulfilling prophecy of falling prices, as consumers expect prices to decline and create it by ignoring purchases.
Note: The Great Depression is an example of the result of uncontrolled inflation.
Inflation may seem beneficial for consumers, but low prices reflect low demand, which arises from decreased demand leading to lower revenues, resulting in layoffs and reduced income for consumers.
Inflation can also result from positive causes – through increased productivity, technological advancements, new resource sources, or innovation. From this perspective, it can be good for the economy as it gives consumers greater purchasing power. The issue is how quickly it occurs.
Investment Tips During Economic Inflation
Investing during a period of economic inflation can be challenging – as asset prices decline, resulting in loss of interest and value in cash, gold, real estate, and stocks. While these assets generally yield in an inflation environment, they tend to create losses during inflationary times.
Note: Among the better investments when prices fall are bond funds, especially long-term bonds, as interest rates decline and bond prices may increase as a result.
Some sector funds that invest in defensive areas, like healthcare, utilities, and essential goods, as well as some raw materials – things that people need regardless of economic conditions – can be good investments during inflationary periods. For instance, people still need to see a doctor, use electricity, and brush their teeth when the economy and stock market are in decline. This demand usually prevents stocks in these sectors from falling as much as the overall market.
The Federal Reserve implements monetary policy to prevent slipping into an inflationary period and tries to keep the duration from being extended. Therefore, investments that perform well when interest rates decline can be good during inflationary periods.
Investment Options During Economic Inflation
Safer More Risky
Funds
Long-term bonds Precious metal funds
Fixed income bond funds Money market funds
Distribution funds (sometimes) investments that depend on rising prices and interest rates
There is a dangerous timing element in the market when trying to choose the best investments during a short-term expected inflation period. Trying to navigate the market and economic conditions with investment strategies is a form of market timing that carries a high risk of losing investment value. For most investors, building a diversified portfolio of mutual funds is the best strategy for all economic and market environments.
Was this information helpful?
Thank you for your feedback!
Sources:
Federal Reserve Bank of Minneapolis. “Consumer Price Index, 1800 -“.
Source: https://www.thebalancemoney.com/what-is-deflation-2466846
.lwrp .lwrp-list-item.lwrp-empty-list-item{
background: initial !important;
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
}@media screen and (max-width: 480px) {
.lwrp.link-whisper-related-posts{
}
.lwrp .lwrp-title{
}.lwrp .lwrp-description{
}
.lwrp .lwrp-list-multi-container{
flex-direction: column;
}
.lwrp .lwrp-list-multi-container ul.lwrp-list{
margin-top: 0px;
margin-bottom: 0px;
padding-top: 0px;
padding-bottom: 0px;
}
.lwrp .lwrp-list-double,
.lwrp .lwrp-list-triple{
width: 100%;
}
.lwrp .lwrp-list-row-container{
justify-content: initial;
flex-direction: column;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: 100%;
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
};
}
Leave a Reply