Inflation and deflation

Deflation is a sustained decrease in the general price level. It can lead to decreased consumer spending as consumers delay purchases expecting further price drops, leading to decreased production and economic stagnation. This is known as a deflationary spiral.

Cost-push inflation occurs when there is an increase in the costs of production for firms, which they pass on to consumers through higher prices. An example is a sharp rise in oil prices, which increases transportation and production costs.

Demand-pull inflation occurs when there is an increase in aggregate demand that outpaces the economy's ability to produce goods and services. This leads to a general rise in prices.

High inflation erodes purchasing power, making it more difficult for people to afford goods and services. It also creates uncertainty for businesses, discouraging investment and long-term planning, and reduces international competitiveness.

Deflation can lead to delayed spending as consumers expect prices to fall further, leading to a decrease in aggregate demand and economic activity. It also increases the real burden of debt, making it more difficult for individuals and businesses to repay loans.

A central bank can raise interest rates to combat inflation. This makes borrowing more expensive, which reduces consumer spending and investment, thereby decreasing aggregate demand and putting downward pressure on prices.

An increase in wages can lead to cost-push inflation if businesses increase prices to cover these higher labor costs. It can also lead to demand-pull inflation if higher wages increase consumer spending, driving up demand for goods and services.