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What is deflation and is it better than inflation?

The past year has brought many concerns with regard to the economy. When shopping for groceries or filling the gas tank increases, it's not uncommon to wish prices were going down instead of up.

And there's a name for what sounds like a glorious alternative to higher prices, but the main concern that plagues investors and economists when that happens is deflation, or dropping prices. Basically, instead of worrying about how your dollar will buy less, the concern is that now your dollars will buy more.

But wait, that doesn’t sound so bad, does it? Is deflation preferable to inflation? It depends on your financial situation.

At face value, declining prices seem to be a good thing for consumers, not a bad one. And in that limited respect, deflation could be beneficial for consumers, especially consumers with savings. The challenge is deflation usually happens when plenty of goods are available, but consumers don't have money to spend. Let's break that down.

 

What happens when earnings are down?

Yes, prices go down during deflation, but often it is because money is scarce, or rather, people who need it, don't always have enough. This happens when wages are low or unemployment is high, and also when goods are in strong supply and readily accessible.

Here is the reality for those with less than cushy savings: People will stop shopping. When moving towards deflation, knowing that the prices will eventually drop, spending lags and the economy will inevitably suffer.

Deflation usually makes debt grow rather than shrink. If you owe $1,000 today, you'll have to work harder to pay it back with the dollars you earn tomorrow, because you get less for the same amount of work.

When it comes to correcting the problem, wages and employment adjust more slowly than prices. It's harder for companies to pay employees less rather than to charge less for their products, too. While that's good to hear as an employee, it eventually hurts the profitability of the business, its position (and that of every other company) on the stock market, and eventually the entire economy.

 

The bottom line

The bottom line is that deflation can be good for people who are less concerned about their financial position, especially if they have high savings and low debts. It does tend to negatively impact consumers with little savings, especially if they also have high debt. When wages fall or the unemployment rate increases, these signals definitely give economists and investors a reason to be concerned about the prospect of deflation.

Curiously, this is one area when both inflation and deflation call for one beneficial course of action to prepare for either inflation or deflation: get saving. Building an emergency fund is as much for an unexpected expense, like a major car repair, as it is for padding your budget during times of economic uncertainty.

If you're needing a reason to take a closer look at your savings account, a Kasasa Saver™ account, you can be in the category of high savings and low debt, which means deflation will not have as much of an effect on your finances as those Americans who have not started saving.

Tags: Budgeting, My Finances, Future Planning, Debt Management, Banking