Inflation vs. Deflation which one do you want?

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What is Definition of Inflation?

The technical definition of inflation is the rise in the commodities prices, fuel and everything you use every day.

What is Deflation?

Deflation is the fall in the commodity, oil prices on a weighted average basis.

Why is inflation bad?

If inflation is more than the rise in salaries or if it is accompanied by rise in unemployment rates, it lowers standard of living for the people. Obviously that makes inflation a bad thing overall.

Why is deflation bad?

Deflation also corresponds to fall in demand of goods as well as the inability of people to buy goods.

In both of the above cases manufacturing slows down which further leads to recession and we are caught in a vicious cycle.

Recession makes things more affordable for people with jobs

So whenever economy is in recession, we see prices of commodities like Oil falling. Remember how Oil fell from $150 a gallon to 35$ a gallon in 3 months of start of this financial crises. The Fed responded by increasing money supply in the economy by giving loans at 0% interest rates. When people get loans at low rates they buy more goods, demand increases and prices increase. A perfect economy inflation should be 2-3%. If Fed does not pull back its measures in time there is too much money in market and people end up buying much more and hence further inflation. This leads to pressures on the dollar as a currency as well increase in foreign debt.

Currently Fed announced that in January consumer prices went up by only 0.2%. If you remove the volatile food and gas prices, consumer prices are down by 0.1 %. This happened for first time since 1982. This news was greeted by strong sentiments on Wall Street and it brought back some confidence in the economy. The prices for banks and small businesses increased due to this. Wall Street was worried that the inflation would be going up and hence Fed would have to take drastic measures for their lending rates to banks. This would have reduced banks profitability even though they are still weak and recovering from financial crises. Banks would have in turn less money to small business which meant lower demand and lower growth further (the never ending cycle). However this is not happening. Prices are still at all time low. Walmart reported less same stores sales number this month because the prices of commodities are still falling. This means banks still have cheap access to credit and hence can make more loans and banks can become more profitable. They can also lend much more to small businesses which have seen the growth of American labor force since last 20-30 years.