Inflationary growth
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Price Level
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Real GDP
Inflationary growth was what was taking place in most parts of the world after the year 2000. Prices of goods not only doubled but also trebled and at the same time, growth in most countries reached an all time high. Customers were demanding more and in turn, producers were producing more. Unemployment went at a low because more and more people could be employed by industries to fulfill customer demand. Therefore, the prices of goods went up.
A small percentage of inflationary growth is helpful to assist an economy to grow. But like deflationary growth, excess of inflationary growth has its disadvantages
Prices can be set artificially high and may crash just as fast as they have risen,
In face of rising prices, customers purchasing power may go down
This may result in an excess of goods and services which no one is ready to buy
Growth is often artificial in inflationary growths resulting in recessions later as seen in the recent financial economic meltdown
Both the Keynesians and monetarists agree on the basic concept of inflationary growth but argue on how inflation is caused with one side arguing it is caused by demand side policies while the other advocating both demand side and supply side policies.
Deflationary recession
Recession is described as a period of negative economic growth (Brue, 2006). Deflation hints towards a fall in aggregate demand. This leads to a lower growth rate and a falling GDP. This in turn leads to falling price levels hence negative price levels which are called deflation.
Therefore, almost all recessions have deflationary pressures. When a deflationary recession becomes very serious, it is called a depression. A deflationary recession is explained in the diagram below
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Price level
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Real GDP
In economic terms, decrease in aggregate demands with short term aggregate supply decrease he price level and the real GDP.
A deflationary recession can have many disadvantages
Business opportunities are poor
Business confidence remains low
Investment remains low resulting in further deflation
Firms may cut back o production
Stagflation
The term Stagflation was coined in the late 1970s and was used to refer to the combination of stagnation (low growth and high unemployment) and high inflation. Previously, both monetarists and Keynesians had agreed that there would always be a standoff between high growth and employment versus high inflation but the 1970s and 1980s saw recessions accompanied not only by the familiar high unemployment but also by unexpected rapid inflation. When stagflation came forward, many economists put the phenomenon forward as a failure of Keynesian economics. Milton Friedman put forward the monetarist theory of explain stagflation. He examined the relationship between money supply and prices and concluded that inflation was always and everywhere a monetary phenomenon. Friedman argued that if money supply would rise faster in the long run than the economys potential output of the economy, inflation would be the unstoppable result. Hence, the term money chasing goods was coined.
The monetarists also bought forth the long run Phillips curve to explain further the stagflation concept. It depicted that unemployment is temporarily reduced by raising aggregate demand. The more the demand, the more the goods and services which would be needed and the more people employed to create them. Similarly, unemployment can be temporarily increased by reducing aggregate demand but in the long run, an equilibrium level of unemployment is created consisting of frictional, structural and technological unemployment. It can be reduced by increasing mobility of workers. Similarly, inflation in the monetarist opinion is entirely dependent on aggregate demand and in turn to the money supply. In the short run, there can be a tradeoff between unemployment and inflation but in the long run, once expectations have been adjusted, unemployment rises to its original level. Thus, long run Phillips curve is vertical.
Inflation
Unemployment
LONG RUN PHILLIPS CURVE
Deflationary growth
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Price
Aggregate Demand
National Income
Deflationary growth stems from an increase in efficiency and productivity. Supply and demand of money remains unchanged but there is an increase in the production of goods and services. In simpler words, the same amount of money now purchases more goods. This results in falling prices of goods.
Increases in short run aggregate supply and long run aggregate supply exceeds increase in aggregate demand, decreasing the price level and increasing the national income. This idea is now regarded by people living in the era of inflation to be outdated but for people living in the 1800s this held true. Even today, Japan is a country where deflationary growth continues to take place.
It is not harmful and economists have come to accept that deflationary growth, to a certain extent, is good as it points towards the worlds increasing productivity. For example the technological trend of deflation in which the prices of hi-tech goods have gone down drastically over the decade is improving profit margins and adding value to the goods and services produced. It may have hurt producers but in the long run, is envisioned to bring cost savings.