The words inflation and deflation are often synonymous for price increases and decreases. However, this is not always the case as prices can actually decrease during inflationary periods and prices can increase during deflationary periods.
In order to understand these concepts it is first important to have a pure definition of these terms. As it pertains to economics and monetary policy, the word inflation means to increase the money supply, while deflation is a reduction in the money supply. At least this is what the words used to mean, but today you will see prominent economic debates taking place where the words are now defined as price increases and decreases. It is more accurate to state that inflation is an increase in the money supply, a result of which is often an increase in prices.
The Bureau of Labor Statistics created the CPI (Consumer Price Index) to track the living expenses of families. Today, when the Federal Reserve Chairman testifies in front of congress, he uses the words inflation and CPI interchangeably. Using these two words interchangeably is dangerous for the people of a country as it gives the government of those people an excuse to go deeper into debt during times of true economic prosperity.
When a government that operates with a fiat currency, such as the United States, decides to run large annual deficits and increase the national debt, they do so by selling treasury bonds (IOUs). When there are not enough buyers of this debt from the people, the country turns to foreign countries and their federal bank to monetize the debt. Monetizing the debt simply means that the federal bank creates new currency out of thin air and trades that currency to the government’s treasury department for the IOU bonds.
During times a economic prosperity, the living standards of people go up without them having to do more work. Take the profession of a school teacher which for the most part does the same job year after year. Lets say a ten year veteran school teacher is able to afford a 2 bedroom apartment, a midsize car, eating at restaurants once a week, and one all inclusive week long vacation to Mexico with his salary. If five years later, another 10 year veteran teacher can now afford a 3 bedroom house, a full size car, eating at restaurants twice a week, one all inclusive week long vacation to Mexico, plus a long weekend vacation trip to Las Vegas and have $2,000 left over to invest, this shows the economy has approved. Basically, the same amount of work is able to be traded for more goods and services.
If the same amount of work is able to buy more goods and services, then CPI is actually going down, and many would see this as deflation. Though deflation is often seen as a boogieman that must be avoided at all cost, it is actually a good thing if it is happening during economic growth. But what if instead of allowing the people to enjoy cheaper prices for the goods and services they buy, and thus the opportunity to purchase more goods and service, the government instead decided to increase the money supply as a result of running up large deficits to finance an increase in the size of government?
Now, instead of the teacher enjoying a better standard of life, his wealth prospects – the nicer car, more trips to restaurants, weekend vacation to Vegas, and extra investing money – are being stolen through inflation and currency expansion. Here is a situation, where despite the economy growing, and thus creating a better standard of living for the teacher, his standard of living remains the same as wealth is transferred out of his paycheck and straight to the government. Some will say that the wealth the government abstracts from the people is justified as the government will produce an equal amount of good for society, and maybe even more, then the wealth that it abstracts from each individual. I would disagree with that by pointing to the many inefficiencies of government now and through history.
Since the financial collapse in 2008, the treasury has almost tripled the debt and has run up annual deficits while the federal reserve has provided much of the currency for this spending and thus has created a lot of inflation. Meanwhile, the BLS has reported inflation rates under 4% every year since 2009. Government officials have used this data to convince themselves that printing money has little to no negative effect on the day to day spending and wealth accumulation for people working hard for their paychecks. This during a time of a great expansion in internet businesses which has greatly reduced inefficiencies in countless business industries, resulting in lower prices for consumers.
Think about cable television monthly prices to Netflix; taxi rates to Uber, sending mail to using email, long distance calling in the 90s to hopping on Whattsapp to talk to friends half way around the world for free. There are countless other examples, all of which have made life easier and less expensive for billions of people. And during this time what has happened, the CPI has “only” gone up by 2-4% a year. Instead of the overall cost of life – as calculated by the CPI – going down during a time of great technological advances in business, it has actually gotten more expensive to live. This wealth is being taken by the government through actual inflation, which has been the massive expansion of the currency supply.