Reflation

DEFINITION of 'Reflation'

Reflation is a fiscal or monetary policy, designed to expand a country's output and curb the effects of deflation, which usually occurs after a period of economic uncertainty or a recession. As such, the term "reflation" is also used to describe the first phase of economic recovery after a period of contraction.

Reflation policies can include reducing taxes, changing the money supply and lowering interest rates. Furthermore, reflation is a long-term shift, often characterized by a prolonged reacceleration in economic prosperity that aims to reduce any excess capacity in the labor market. 

BREAKING DOWN 'Reflation'

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.

In the wake of the Great Recession, the U.S. economy remained subdued and the Federal Reserve struggled to create inflation. Despite a number of reflationary monetary policy tools such as lower interest rates and increased money supply, inflation remained below the Fed's target. It wasn't until the election of President Donald Trump that the economy got a sniff of fiscal reflation. Trump pledged a trillion dollar infrastructure bill and far-reaching tax cuts in the hope to boost the economy to full capacity. His ambitious policies led to the term "Trump Reflation Trade."

The tax reform will be voted on towards the end of 2017. (Further reading: Trump's Tax Reform Plan)

Reflation v Inflation

It is important not to confuse reflation with inflation. Firstly, reflation is not bad in that it is a period of price increases when an economy is striving to achieve full employment and growth, whereas inflation 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.