Why do inflation and deflation occur?

📘 In Brief Inflation occurs when demand for goods and services exceeds supply. Companies can then raise prices because buyers are willing to pay more. Rising production costs, such as for energy or wages, are also passed on to consumers. Additionally, a strong expansion of the money supply by the central bank can reduce the value of money, which also drives prices up. Deflation is the opposite: prices fall persistently. This happens when demand collapses or supply increases sharply, for example due to technological progress. Deflation is particularly dangerous when people postpone purchases because of falling prices, waiting for even lower prices. This further reduces demand, forcing companies to cut prices and wages, which can drag the economy into a downward spiral. Both phenomena are therefore consequences of an imbalance between the money supply, supply, and demand. 🔍 Why This Matters Inflation occurs when aggregate demand persistently exceeds supply. Causes include an increase in the money supply, rising production costs (e.g., energy, wages), or expectation-driven price-wage spirals. Central banks respond with interest rate hikes to make lending more expensive and dampen demand. Deflation is the opposite: a general, sustained fall in prices. It occurs when supply and demand diverge, for instance due to technological productivity, debt reduction, or a demand slump after crises. Consumers postpone purchases in anticipation of further falling prices, which further weakens demand. Both phenomena are disruptions to price equilibrium. Infl …