Topic 5: Inflation and Deflation
1. Inflation
Inflation is a persistent rise in the general level of prices, which reduces the value (purchasing power) of money.
Types
- Demand-pull: total demand exceeds supply (too much money chasing too few goods).
- Cost-push: higher costs of production (wages, fuel, raw materials) raise prices.
- Imported inflation: rising prices of imported goods.
- Creeping, galloping and hyperinflation: slow, fast and extremely rapid price rises.
Causes
- Excess money supply.
- High government spending and deficit financing.
- Rising wages and production costs.
- Shortages (poor harvests, supply disruptions).
- High import prices and a weaker currency.
- High demand from credit expansion.
Effects
| Group |
Effect |
| Consumers |
Reduced purchasing power; higher living costs |
| Savers |
Value of savings falls |
| Fixed income earners |
Real income falls |
| Borrowers |
Gain as debts lose real value |
| Businesses |
Higher costs and uncertainty |
| Economy |
Reduced exports, investment and growth |
2. Controlling Inflation
a) Monetary Policy (Central Bank of Kenya)
- Raise the Central Bank Rate and interest rates.
- Increase the cash reserve ratio.
- Sell government securities to remove money from circulation.
- Restrict credit.
b) Fiscal Policy (Government)
- Increase taxes.
- Reduce government spending.
- Run a budget surplus.
c) Other Measures
- Price controls and subsidies.
- Increase production and supply.
- Control wage increases.
- Reduce imported inflation by stabilising the currency.
3. Deflation
Deflation is a sustained fall in the general price level.
Causes
- Reduced demand and money supply
- Increased production efficiency
- High interest rates and tight credit
Effects
- Reduced business profits
- Unemployment
- Delayed consumer spending
- Debts become harder to repay
Control
- Lower interest rates
- Reduce taxes
- Increase government spending
- Increase the money supply
4. Stagflation and Reflation
- Stagflation: high inflation with high unemployment and slow growth.
- Reflation: policies used to raise output and prices after deflation.