Inflation means a reduction in the value of money, or a rise in general price levels. If the amount of money in a country (referred to as the money supply) grows faster than production in that country, the average price of goods and services will rise as a result of the increased demand.
Governments keep a close eye on inflation levels and try to keep it low. Public sector officials collect vast quantities of data every day to ensure that governments have a precise overview of the current state of their nation’s inflation rate.
Periods of low inflation are generally desirable for governments, as it means prices are rising slowly and the economy is more stable. But, not everyone in society comes out of low inflation as a winner. Continue reading to explore what causes low inflation, and discover who the real winners and losers are.
Low inflation — or economic deflation — is a general decline in the price level of goods and services.
There are a variety of contributing factors towards low inflation, but it is usually associated with a reduction in the supply of money and credit. Price levels can also fall as a result of increased productivity, technological innovation, and decreased spending from less demand for goods and services.
How Does Low Inflation Affect the Economy?
At first glance, lower prices may seem beneficial, but if pushed to the extreme a deflationary spiral can quickly send shockwaves through an economy — potentially resulting in a recession, or worse, a depression.
During times when economic output slows down, it is common for the demand for investment and consumption to dry up. In turn, this leads to a decline in asset prices as businesses and manufacturers are left with little alternative but to liquidate inventories that consumers no longer want to buy. When the economy slows, consumers and businesses begin to hold onto their money to create a financial buffer against any further monetary loss.
To combat deflation governments and central banks often aim to stimulate the economy, for example: by lowering interest rates.
How Does Low Inflation Affect Businesses?
Low inflation leads to unemployment when businesses make less money from lower consumer demand, and react by cutting costs in order to survive. Businesses may respond by closing stores, warehouses and laying off employees to preserve budget and profitability.
The economic situation only worsens when workers have to decrease their own personal spending, leading to even less demand and a spiral of low inflation that is difficult to break.
That said, low inflation can work without damaging the rest of the economy when businesses successfully cut production costs to lower prices with innovative technology. Over the years, the cost of technology has tended to decrease. Uniquely, this is because the cost of producing new technologies has reduced, not because demand has decreased.
Debtors on Fixed Repayment Plans
Lower rates of inflation can make it harder for companies and individuals to pay back outstanding debt on fixed repayment plans. Only during times of high inflation can businesses increase prices for goods and services, and use the extra revenue to pay outstanding debts.
Owners of Land and Physical Assets
While not strictly a direct loser of low inflation, owners of land and other physical assets tend to benefit from greater economic protection during periods of high inflation. This is because land, factories and technology retain their value, unlike financial assets.
National Governments with High Public Sector Debt
Low inflation makes it harder for governments to avoid increasing the real value of its debt (namely the public debt as a percentage of GDP). During periods of low inflation, since money supply is tightened, there is an increase in the value of money, which in turn increases the real value of debt.
Traditionally savers win from lower levels of inflation. If prices fall, the value of money rises, and the real value of savings increases. During periods of high inflation, people who had saved all their life could see the value of their savings wiped out because, with high prices, their financial savings are effectively worthless.
Borrowers on Variable Mortgage Rates
A drop in inflation can cause the government or central bank to decrease interest rates. Often, this leads to a higher borrowing rate. With lower interest rates mortgage owners who have variable rates could benefit from a significant rise in their mortgage payments.
Retirees Living on Fixed Incomes
A high inflation rate often means wage increases, but that rarely benefits people who are retired since retirement money is a fixed income. Low inflation, and lower prices of goods and services, helps retirees stretch their money further.
National & International Economies
Generally, low inflation creates a greater sense of certainty for consumers, banks and businesses. More confidence in the market to invest leads to higher levels of economic growth and increased job availability. In the long-term, lower levels of inflation are associated with more prosperous economic conditions.
Stay on Top of the Latest Industry Trends with INAA
We’re the International Association of Independent Accounting firms, established over 25 years ago to facilitate cross-border business.
Here at INAA, we connect accounting firms who aim to deliver quality professional services around a shared vision to make global business personal, and take personal business global. Our collaborative association of international businesses is committed to being a part of the conversation around the future of finance.
Join today to start building powerful business relationships.