Inflation, disinflation, and deflation: what is the difference?

The short answer

• Inflation is a sustained increase in the general price level.
• Disinflation is a slowdown in the rate of inflation. Prices are still rising, but more slowly.
• Deflation is a sustained decrease in the general price level.

The three are often confused because all involve prices. The policy implications are different.

Inflation

Inflation means the purchasing power of money is falling. If prices rise 5% in a year, a basket that cost $100 now costs $105. The inflation rate is the percentage change in a price index, such as the consumer price index.^[1]

Inflation can be driven by demand, supply, expectations, and money and credit growth. The mix matters. A supply shock that raises energy prices is different from a demand boom that pushes the economy beyond capacity.

Disinflation

Disinflation is a decline in the inflation rate. If inflation falls from 6% to 3%, that is disinflation. Prices are still rising, but at a slower pace.

Disinflation is not deflation. A central bank trying to bring inflation down is aiming for disinflation, not a falling price level. The danger is that tightening too much can tip the economy into a recession or deflation.

Deflation

Deflation is a sustained fall in the general price level. It can be caused by a collapse in demand, a credit contraction, or productivity gains that lower costs.

Deflation is not always bad. Productivity-driven deflation can coexist with growth. But when deflation interacts with high nominal debt, it can be corrosive. Falling prices and incomes raise the real burden of debt, forcing borrowers to cut spending and sell assets, which can push prices down further.^[2]

Why the distinction matters

• A central bank can tolerate disinflation; it usually wants to avoid deflation.
• A supply shock can raise inflation while reducing output; the policy response is different from a demand boom.
• Deflation can make conventional monetary policy less effective when interest rates are near zero.^[3]

Measuring prices

Price indices are imperfect. They track a basket of goods and services, and the basket changes over time. Housing, healthcare, and quality adjustments are all difficult to measure. That is why economists look at multiple measures, including core inflation, wages, and inflation expectations.

Money-supply data can provide context, but the relationship between money growth and inflation is not mechanical.^[4]

The bottom line

Inflation, disinflation, and deflation describe different price dynamics. The words are not interchangeable, and the policy response depends on which one is happening and why.