Are we experiencing inflation or reflation, and why does it matter? This is a fundamental question to consider when dealing with the business effect of inflationary costs. Let me explain these concepts and why you should consider them in your business.
While inflation is somewhat of a foreign concept to Americas younger than the Gen X (and in reality, Baby Boomers), we all have a basic understanding. Inflation as defined by Wikipedia:
“Inflation … is a general rise in the price level of an economy over a period of time.”
Such price increases usually come from supply and demand issues where too much money is chasing too few goods. An example of traditional inflation was the 1970s in the United States. The stock market dropped. There was high unemployment. Shortages included the infamous energy crisis. Furthermore, fiscal policies led to increasing the money supply to boost the economy. Sound familiar?
A reversal of monetary policy arrested this inflation. Interest rates were raised to extraordinary and painful levels before settling into model levels in the late 1980s.
What we are experiencing in 2021 is unique, but also has some similarities to the 1970s. For more on our current situation, I outlined some of the reasons for 2021 inflation in my article The Impact of Inflation on Business in 2021 and What To Do.
A term that is being used in economic circles is reflation. This is the concept that we are re-inflating a paralyzed economy. Makes sense if you consider the abrupt halt to economic activity with COVID restrictions in 2020. Now that we’re coming out of those restrictions, there is pent up demand. In addition, people are spending money that was saved as well as government stimulus.
This concept of reflation would indicate a short-term effect as there is a push to resumption of normal economic activity. Once we’ve blown through our savings and stimulus checks and the supply chain gets normalized, demand is expected to slow down, and prices will too.
If you believe this is what we are experiencing, remember that the world has spent over a year (and going) of economic restrictions. So, this short term could still last many months or quarters. But it is unlikely to last over a decade, as was the case in the 1970s and 1980s in America.
Inflation or Reflation: Why it Matters
Right now, the Federal Reserve, who controls United States interest rates believes what we are experiencing is a result of short-term reflation and therefore is keeping interest rates low. There is still a good amount of unemployment so it’s lots of money, stimulus, and low interest rates.
So, are we experiencing inflation or reflation? If reflation is what we are experiencing, businesses can plan on price increases to last for a shorter period, but as I noted, don’t underestimate the length of this period. Prices may need to step up in line with rising business costs, but eventually those cost increases will stabilize.
If what we are experiencing is longer term inflation, plan to raise prices over and over to stay in line with rising costs. Inventory turnover may be easier as what you buy today can be sold at a higher price tomorrow. That said, inflation is a vicious cycle where optimal pricing can be hard to achieve and mistiming can leave a business with lower profits.
The best advice is rigorous attention to business costs and readiness to adjust prices as needed, whether we are experiencing inflation or reflation.