Quick Answer
Inflation is a sustained rise in prices; deflation is a sustained fall. Disinflation just means inflation is slowing, prices are still rising. Stagflation combines stagnant growth, high unemployment, and high inflation. Inflation hurts lenders and fixed-income investors and helps borrowers; deflation does the reverse. CPI, published monthly by the BLS, is the primary inflation gauge.
Inflation is the backdrop for most of the rest of this unit: it is what the Fed's rate decisions typically respond to, and it is why a bond's stated interest rate is not the same as what an investor actually keeps in purchasing power. The next lesson builds directly on the real-return concept introduced below.
Core Definitions:
- Inflation: A sustained increase in the general price level of goods and services over time
- Deflation: A sustained decrease in the general price level (opposite of inflation)
- Disinflation: A slowing in the rate of inflation (prices still rising, but more slowly)
- Stagflation: Combination of stagnant economic growth, high unemployment, and high inflation
- Hyperinflation: Extremely rapid, out-of-control inflation (prices rising dramatically)
Exam Tip: Gotchas
- Disinflation is not deflation; prices are still rising, just more slowly. Stagflation combines inflation with stagnation (high unemployment plus low growth), the worst of both worlds. The exam tests these distinctions closely.
Who Wins and Who Loses from Inflation?
- Erodes purchasing power of fixed-income investments (bonds, fixed annuities)
- Hurts lenders and fixed-income investors (they receive dollars worth less)
- Benefits borrowers (they repay debt with less valuable dollars)
- Real return = nominal return minus inflation rate
Who Wins and Who Loses from Deflation?
- Increases purchasing power of money
- Benefits fixed-income investors (dollars received are worth more)
- Can signal severe economic weakness (reduced demand, falling prices, rising unemployment)
How Is Inflation Measured?
- Consumer Price Index (CPI): the primary inflation gauge; measures price changes in a basket of goods and services commonly purchased by households
- Published monthly by the U.S. Bureau of Labor Statistics (BLS)
- The Fed monitors CPI to guide monetary policy decisions
What Should You Check on Exam Day?
- Keep inflation, deflation, disinflation, stagflation, and hyperinflation distinct; disinflation still means rising prices, just more slowly
- Match winners and losers correctly: inflation hurts lenders and fixed-income holders and helps borrowers; deflation reverses that
- Be able to compute real return as nominal return minus the inflation rate
- Remember CPI is published monthly by the BLS and is the figure the Fed watches most closely