What is disinflation?

In macroeconomics, the disinflation definition refers to the periods when the rate of inflation falls over a short period of time.

Disinflation is frequently confused with deflation, which refers to a drop in the price of goods or a negative inflation rate. Prices may continue to rise during a disinflationary period, but at a slower rate. 

In short, disinflation refers to the rate of change in the inflation rate, while deflation refers to the direction of prices. For example, when the inflation rate slows from 4% to 3%, that is a period of disinflation. On the other hand, deflation shows a negative growth rate, such as when the prices fall 2%.

Disinflation is not a symptom of a faltering economy. Economies need disinflation as it protects it against the dangers of overheating or hyperinflation, a period when prices rise faster and more rapidly than income rates.

Disinflation example

During the 1970s, the US experienced what was known as the Great Inflation with prices surging more than 110%.

In early 1980, the annual rate of inflation reached 14.76%. Price growth started to decrease in the 1980s after the US Federal Reserve’s (Fed) aggressive monetary policy of hiking interest rates up to 20%. 

Factors causing disinflation explained

Disinflation can be caused by a central bank’s decision to tighten monetary policy to reduce money supply in the economy to fight inflation. Inflation can be caused by an increase in the supply of money in the economy.

An economic recession can also cause disinflation. During recessions, businesses may be reluctant to increase their prices to attract more customers or keep their existing market share, which subsequently causes disinflation. 

How does disinflation work?

Inflation, disinflation or deflation is determined by the Consumer Price Index (CPI). CPI tracks changes in the price level of consumer goods and services, which evaluates when an economy is experiencing disinflation, inflation or deflation.

The percentage difference in CPI - positive or negative - is what constitutes inflation, deflation, or disinflation. The index is closely followed by investors, central banks and other players.  

For example, between March and April 2022 the US inflation rate fell from 8.5% to 8.3% - a brief period of disinflation. Yet the inflation rate then picked up again rising to 8.6% in May.