Definition of negative inflation
What is negative inflation?
Negativeinflation is a general price decrease that is not sustainable. This is a temporary decrease that is part of a general trend of rising prices. It is important to distinguish between negative inflation and deflation. The term deflation can only be used if the decline occurs over 3 consecutive quarters, so the general price trend is downward.
What are the causes of negative inflation?
Negative inflation is often caused by a sharp drop in the price of certain goods or services. Remember that, to calculate the inflation rate, theconsumer price index (CPI) is used. This integrates the different items of household expenditure. Some items are more volatile than others. These are mainly energy and food which vary greatly according to the seasons and also according to changes in supply and demand. They have a strong impact on the inflation level. If the price decline is significant, this can temporarily lead to inflation in negative territory. This is then called negative inflation.
This is why the central banks in charge of controlling inflation use the consumer index excluding energy and food. It provides a more relevant view of the real trend in inflation and eliminates the temporary effects of a fall in prices. With this indicator, it is much rarer for a country to have negative inflation.
Consequences of negative inflation
The consequences of negative inflation are limited. If it is due, for example, to a fall in oil prices, and the prices of other expenditure items have remained stable, negative inflation has no impact on economic activity.
Negative inflation is a period of falling prices during which consumption remains relatively stable. In the short term, this can even have positive effects on consumption. On the other hand, if the price decline continues, we can enter a deflationary phase. With the fall in prices, companies' margins decrease, and this leads to a decline in wages and, in the long run, in household consumption. Companies reduce their investment and economic activities to go into a recession. For the State, this is a drop in revenue. So it's a vicious circle which it's very difficult to get out of.
That is why negative inflation is frightening. Effectively, the borderline between deflation and negative inflation is thin, but the effects are very different.
Negative inflation is feared by central banks. They try to avoid it at all costs and then resort to a reduction in rates and the banknote printing technique (increase in the money supply) to generate inflation.