Inflation and deflation

Inflation occurs when the price of goods and services rise, while deflation occurs when those prices decrease. The balance between the two economic conditions is delicate, and an economy can quickly swing from one situation to the other.

Inflation is caused when goods and services are in high demand, creating a drop in availability. Consumers are willing to pay more for the items they want, causing manufacturers and service providers to charge more. Supplies can decrease for many reasons: A natural disaster can wipe out a food crop or a housing boom can exhaust building supplies, among other situations.

Deflation occurs when too many goods are available or when there is not enough money circulating to purchase those goods. For instance, if a particular type of car becomes highly popular, other manufacturers start to make a similar vehicle to compete. Soon, car companies have more of that vehicle style than they can sell, so they must drop the price to sell the cars. Companies that find themselves stuck with too much inventory must cut costs somewhere, which often leads to layoffs. Unemployed individuals do not have enough money available to purchase expensive items, which continues the trend.

When credit providers detect a decrease in prices, they often reduce the amount of credit they offer. This creates a credit crunch where consumers cannot access loans to purchase big-ticket items, leaving companies with overstocked inventory and leading to further deflation. Deflation can lead to an economic recession or depression, and the central banks usually work to stop deflation as soon as it starts.