Slower price increases are different from falling prices.
Inflation is a sustained increase in the general price level; deflation is a sustained decrease. Disinflation is a fall in the rate of inflation, so prices can still be rising. Distinguish an aggregate price movement from a change in one product's relative price. A one-off rise in a price index raises the measured inflation rate during adjustment but does not by itself establish continuing increases at the same rate. Use the time period, index coverage and supplied rates carefully; a year-on-year figure and a month-on-month figure compare different intervals.
- Inflation
- Inflation is a sustained rise in the general price level, a measure covering many goods and services rather than just one product.
- Disinflation
- A lower inflation rate; prices may still be rising.
- Deflation
- A sustained decline in the general price level.
Read the base, period and household context
Time interval
An index compares prices with a reference period set to 100. A year-on-year rate compares with the same period a year earlier; a month-on-month rate compares with the previous month. These answer different questions.
Relative price
One item becoming cheaper does not establish economy-wide deflation.
Persistence
If the price index rises from 100 to 104 and then stays at 104, there is no further price rise in the later period. One initial increase does not explain continuing inflation at the same rate.
Household purchasing power
Purchasing power means what income can buy. Compare nominal income, the money amount received, with the prices the household faces. Its spending mix may differ from the index basket, so its costs can rise faster or slower than the headline rate.
| Path | Initial index | Year 1 index/rate | Year 2 index/rate | Interpretation |
|---|---|---|---|---|
| A | 100 | 104 / +4% | 106.08 / +2% | Disinflation; prices still rise |
| B | 100 | 98 / -2% | 96.04 / -2% | Deflation in both periods |
Worked example: Slower price rises versus falling prices
Path A has price indices 100, 104 and 106.08, with supplied annual inflation rates 4% then 2%. Path B has indices 100, 98 and 96.04, with supplied annual rates -2% then -2%.
- In A, prices rise in both periods, but the rate slows from 4% to 2%: disinflation.
- The final price level in A is 6.08% above the base, despite the lower second-period inflation rate.
- In B, the general price level falls in both periods: deflation.
- Neither path tells us how each household's wages or individual prices changed, so purchasing-power effects require more information.
Watch out for this
Inflation falling from 4% to 2% means prices fell 2%.
Prices are still rising, just more slowly. A negative inflation rate indicates a falling price level over that interval.
Check your understanding
Which description fits price indices 100, 104, 106.08 and inflation rates 4%, 2%?
- Deflation in the second period.
- Every price falls by 2%.
- Disinflation with a continuing rise in the general price level.