What Is Reflation?
Reflation is a fiscal or monetary policy designed to expand output, stimulate spending, and curb the effects of deflation, which usually occurs after a period of economic uncertainty or a recession. The term may also be used to describe the first phase of economic recovery after a period of contraction.
- Reflation is a policy that is enacted after a period of economic slowdown or contraction.
- The goal is to expand output, stimulate spending and curb the effects of deflation.
- Policies include tax cuts, infrastructure spending, increasing the money supply, and lowering interest rates.
Reflation aims to stop deflation—the general decline in prices for goods and services that occurs when inflation falls below 0%. It is a long-term shift, often characterized by a prolonged reacceleration in economic prosperity that strives to reduce any excess capacity in the labor market.
Reflation policies typically include the following:
- Reducing taxes: Paying lower taxes makes corporations and employees wealthier. It is hoped that extra earnings will be spent in the economy, lifting demand and prices for goods.
- Lowering interest rates: Makes it cheaper to borrow money and less rewarding to stow capital away in savings accounts, encouraging people and businesses to spend more freely.
- Changing the money supply: When central banks boost the amount of currency and other liquid instruments in the banking system the cost of money falls, generating more investment and putting more money in the hands of consumers.
- Capital Projects: Large investment projects create jobs, boosting employment figures and the number of people with spending power.
In short, reflationary measures aim to lift demand for goods by giving people and companies more money and motivation to spend more.
Reflation policy has been used by American governments to try and restart failed business expansions since the early 1600s. Although almost every government tries in some form or another to avoid the collapse of an economy after a recent boom, none have ever succeeded in being able to avoid the contraction phase of the business cycle. Many academics believe government agitation only delays the recovery and worsens the effects.
Example of Reflation
In the wake of the Great Recession, the U.S. economy remained subdued and the Federal Reserve (FED) struggled to create inflation, even after utilizing a number of reflationary monetary policy tools, such as lower interest rates and increased money supply.
It wasn't until the election of President Donald Trump that the economy got a hint of fiscal reflation. President Trump pledged a trillion-dollar infrastructure bill and far-reaching tax cuts, hopeful that these measures would boost the economy to full capacity.
Reflation vs. Inflation
It is important not to confuse reflation with inflation. Firstly, reflation is not bad. It is a period of price increases when an economy is striving to achieve full employment and growth.
Inflation, on the other hand, is often considered bad as it is characterized by rising prices during a period of full capacity. G.D.H. Cole once said, "reflation may be defined as inflation deliberately undertaken to relieve a depression."
Additionally, prices rise gradually during a period of reflation and fast during a period of inflation. In essence, reflation can be described as controlled inflation.