Definition: Inflation is when prices rise, and deflation is when prices fall. You can have both inflation and deflation at the same time in various asset classes. When taken to extreme, both are bad for economic growth, but for different reasons. That's why the Federal Reserve, the nation's central bank, tries to control them. Here's how to recognize the signs of rampant inflation and deflation, and to protect your finances.
How to Tell the Difference Between Inflation and Deflation
There are fives types of inflation. The worst is hyperinflation. That's when prices rise more than 50% a month. Fortunately, it's rare. That's because it's only caused by massive military spending. On the other end of the scale is asset inflation, which occurs somewhere nearly all the time. For example, each spring oil and gas prices spike because commodities traders bid up oil prices. They anticipate rising demand at the pump thanks to the summer vacation driving season.
The third type, creeping inflation, is when prices rise 3% a year or less. It's somewhat common. It occurs when the economy is doing well. The last time it happened was in 2007.
The fourth type is walking, or pernicious, inflation. Prices increase 3-10% a year, enough for people to stock up now to avoid higher prices later. Suppliers and wages can't keep up, which leads to shortages or prices so high most people can't afford the basics.
The fifth type, galloping inflation, is when prices rise 10% or more a year. It can destabilize the economy, drive out foreign investors, and topple government leaders. It's a result of exchange rate fluctuations.
Deflation is when prices fall, but it can be difficult to spot. That's because all prices don't fall uniformly, and you can even have inflation in some areas of the economy.
For example, there was deflation in oil and gas prices in 2014, while prices of housing continued to rise, although slowly. However, the Federal Reserve measures the core inflation rate, which takes out the volatile price changes of oil and food.
