Everyone from Wall Street to main street has obsessed over inflation lately, but would you be surprised to know there are actually several different types of inflation? Indeed, there are six main types of inflation, each of which has unique implications for the economy.
Inflation refers to the rate at which prices increase in an economy over time. Everything from groceries and gas to real estate and movie tickets has experienced the sometimes harsh throes of inflation over the years.
As inflation climbs, money loses value as its purchasing power declines. For example, back in 1959, you could buy a Coca-Cola for as little as 5 cents. If you can find that price today, please, let me know!
Inflation is a natural and persistent phenomenon that responds to important economic structures like supply, demand and unemployment. Understanding the different types of price growth is an important step in understanding how the economy operates.
Inflation Defined: Six Main Types of Inflation
The six major kinds of inflation include:
- Hyperinflation
- Stagflation
- Disinflation
- Deflation
- Cost-Push Inflation
- Demand-Pull Inflation
Hyperinflation
Hyperinflation, as its name suggests, is extremely strong inflation, reflecting price growth of at least 50% or more per month. Though, this doesn’t really tell the full story. Hyperinflation is a devastating condition in which money is rapidly devalued, usually to the detriment of the people within the economy.
The most famous example of hyperinflation is Germany in the early 1920s, when inflation climbed to 30,000% per month. Zimbabwe had even worse hyperinflation in 2008, when prices soared by roughly 79,600,000,000%.
When inflation rises that fast, currency loses nearly all value. In Germany, people started using bank notes as tinder to light stoves and start fires because it was easier than hauling a wheelbarrow of paper money to the store to buy firewood!
Stagflation
Stagflation is another dreaded economic extreme being the combination of stagnant economic growth, high unemployment and rampant inflation. While rare, stagflation is considered a worst-case scenario for an economy — and especially its central bank.
Central banks primarily use interest rates to affect certain aspects of the economy. When economic growth is slow, the central bank can lower rates to induce higher spending, causing faster inflation and lower unemployment. On the other hand, if inflation is too high, the central bank may raise rates to inhibit economic expansion and raise unemployment, thus slowing price growth.
Stagflation, however, presents all these problems at once. This gives the central bank no obvious path forward as it pertains to monetary policy. Under stagflation, raising rates to lower inflation would only worsen unemployment and further dull economic growth. On the flip side, lowering rates may improve spending and unemployment, but would also prompt more inflation. Left alone, stagflation can spiral into a potentially destructive recession or depression.
Both the United States and United Kingdom experienced stagflation in the 1970s. However, price controls and a wage freeze imposed by President Richard Nixon — combined with extreme monetary policy changes — allowed the economy to recover with relatively little long-term damage.
Disinflation
Disinflation refers to the temporary slowing of inflation. Unlike hyperinflation and stagflation, disinflation is both a healthy and regular occurrence in economies of all types.
The term describes scenarios in which the pace of price growth has decelerated over the short term, usually on a monthly or yearly basis. That is to say, prices are still climbing month-over-month, just not as quickly as in the past.
The U.S. economy is actually in the midst of a disinflation cycle right now. High interest rates have pushed inflation down to around 3% annually, from its peak at roughly 9% just a couple of years ago.
Deflation
Deflation, or negative inflation, occurs when prices actually decrease from their previous level. Unlike inflation and disinflation, deflation isn’t a normal occurrence in a healthy economy. Indeed, deflation is usually symptomatic of an economy under duress.
Under normal conditions, prices will climb over time as an economy expands alongside its population and productivity. That is to say, inflation is an organic aspect of a healthy economy. However, certain conditions may arise that force prices downwards.
A negative demand shock, for example, may reduce the aggregate demand for goods in a country, forcing producers to either cut back on production — often accompanied by widespread layoffs — or lower prices. This shock can be caused by anything from a drop in government spending, a stock market crash, a spontaneous jump in economic uncertainty, or even monetary policy changes.
Deflation can spiral into a persistent economic contraction in the form of recession or depression, making it a generally negative phenomenon. That’s not always the case, though.
In fact, deflation can also happen when the output of an economy grows faster than the supply of money, usually coinciding with rapid technological changes. As new technology drastically improves productivity, supply may temporarily outpace demand, pushing prices down in the process.
Cost-Push Inflation and Demand-Pull Inflation
Cost-push inflation and demand-pull inflation refer to two distinct sources of price growth. As such, some of the other kinds of inflation previously discussed — like hyperinflation and disinflation — can be caused as a result of changes in cost-push or demand-pull inflation.
Cost-push inflation manifests from increasing costs of production. As the cost of inputs like land, labor or capital rise, producers will frequently raise the prices of goods to maintain profit margins.
This is especially common when businesses are faced with new taxes and are able to pass the incidence of the taxes over to their customers. For example, when cigarettes were first taxed, many tobacco companies simply raised prices, understanding they were likely to maintain most of their customers even despite the increase in prices — a testament to the addictive quality of cigarettes. On an economy-wide level, this will weigh on consumer prices in the form of inflation.
Demand-pull inflation results from, well, demand “pulling” up prices. As demand for goods surge, as a general principle of economics, prices rise. Should aggregate demand surpass aggregate supply, economies will generally experience inflation.
Examples of demand-pull inflation are virtually everywhere. Airline tickets, hotel rooms, gasoline — anything that can experience a rapid influx of demand has likely experienced demand-pull inflation at some time or another.
While there are plenty of other inflation drivers, cost-push and demand-pull inflation are by far the most common types you’ll hear about today.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
