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.

Key Takeaways

  • 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.

Understanding Reflation

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 Methods

Reflation policies typically include the following:

In short, reflationary measures aim to lift demand for goods by giving people and companies more money and motivation to spend more.

Special Considerations

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.

The term reflation was first coined by American neoclassical economist Irving Fisher, following the 1929 stock market crash.

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 sniff 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.

His ambitious policies led to the term "Trump Reflation Trade." The trade? Buying equities and selling bonds.

Important

The biggest winners of reflation tend to be commodity, bank, and value stocks.

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.