Question

Is it good for an economy to experience sudden inflation or deflation? Explain with relevant examples.

Answer 1

Low-level inflation (2–4 per cent) would indicate the economy is doing well, indicating maybe a steadily rising aggregate demand that would mean resource employment and a increasing economy. This will then mean an increase in jobs, an increase in tax revenues and an improvement in living conditions at the end of the day. All in all, the effect of an economy that is on the right track most of the time is minor inflation

It is when the economy enters a state from which they have expended all their resources but still see an rise in the aggregate demand of the economy (an overheating economy) or when the government, in attempts to overcome its budget deficits, turns to the production of capital, that they see themselves trapped in a hyperinflation situation. Hyperinflation is a situation where prices are skyrocketing much faster than output / income rises, or where the value of local currency is dropping due to the dropping real stock money due to excessive money formation.

If deflation does occur. You don't know when prices will stop dropping, so most likely you'll keep your spending in hopes of prices going to fall even more tomorrow, particularly on big-ticket items like cars and real estate. Holding spending will mean lowering economic transactions further slowing down the bad bad economy, particularly as deflation normally happens as aggregate demand drops first. And deflation causes a country that might already be in recession to sink much further into it.

However, what makes deflation worse is that governments are not as easy to handle as they are when dealing with hyperinflation. Hyperinflation can be addressed with very traditional monetary or fiscal contraction, but the normal expansionary versions of these policies would not work for deflation, given how people would still postpone their spending.