Disinflation – What is it?

Definition of Disinflation

By Tim McMahon

To fully understand disinflation we need to first understand inflation.  The reasons this is trickier than it first appears is because the word inflation is actually used in two different contexts.

The most common usage of the word inflation means rising prices.  Commonly “consumer prices”  so when you go to the gas station or the grocery store and the things you buy cost more than last month (or when it is really bad even more than last week) this is more precisely defined as “price inflation”.

The second meaning of the word inflation is actually the original meaning.  And that is an increase in the money supply that causes “price inflation” and this is called “monetary inflation”.

Inflation is measured by an index called the “consumer price index” and the percentage change in this index from one year to the next is commonly called the inflation rate.  This is a measure of price inflation.

So now the question is which “inflation” are we “dis”-ing.  Once again in common usage “Disinflation” means that prices are not rising as fast as they once were.

So if the inflation rate is 5% one month (for the previous 12 months) and the following month it drops to 4% (for the previous 12 months) we have experienced 1% disinflation.

Note that 11 of the monthly periods in this example overlap so the major difference occurred between the first month of the first period and the last month of the second period.

Often people confuse disinflation with deflation.  Perhaps because they think disinflation is the opposite of  inflation.

This however is not the case,  in some ways disinflation is kind of like baby inflation.  In disinflation, prices have not yer fallen which would be the opposite of rising prices they have simply stopped rising as fast as they once were.

Deflation on the other hand is where prices have stopped rising altogether and are actually falling.  So in our previous example we had an inflation rate of 5% when the rate dropped to 4% we had disinflation and if it dropped all the way to a negative 1% (-1%) we would then have deflation (falling prices).

Recently we have experienced deflation in the price of gasoline as it went from over $4.00/gal down to $2.00/gal. we have had 50% deflation in the price of gasoline.

Spotting disinflation in the real world is much more difficult.  If the price of  gasoline was $4.00 one month and $4.40 the following month we could recognize a monthly inflation rate of 10%.

If the following month the price was $4.62 we would say prices inflated by 5% this month because they were up 5%. We wouldn’t say that they disinflated by 5% because they rose 5% less than the month before.

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