Disinflation v. Deflation

Inasmuch as it is the start to a new year I figured this would be an opportune time to discuss something that has been on my mind and recently seems to be misunderstood by a significant number of lay individuals.

While the words in the title of this post may imply similarities they are differentiated by singularly unique identifiers and consequences.

Disinflation is a slowdown in the rate of price increases.  In the real world prices prices might be continuing to climb but they're rising at a slower pace.  Think: 18 months ago inflation was 6%; today it is 3%.  Causes of disinflation include central bank (Federal Reserve) policies that tighten credit by means of raising interest rates to cool consumer demand for goods and services.  If the policy is successful it results in slowing the growth of inflation by stabilizing growth in prices. 

Deflation is a decrease in the general price of goods and services (negative inflation) meaning prices are actually falling.  Think: 18 months ago the price of a gallon of unleaded regular was $3.15 a gallon; today it is $2.30 a gallon.  Causes of deflation can include oversupply or increased productivity as well as tightening of monetary policy leading to decreased demand.  Generally-speaking, deflation can be harmful as consumers naturally may delay purchases if their expectation is for lower prices in the future.  This can lead to a drop in demand, reduced business profitability, wage reductions and a deflationary spiral.

So, what does that have to do with the price of tea in China?  Not much.  It has more to do with perceptions and messaging. 

During his campaign, and since taking office a year ago, Donald Trump has made repeated promises to bring down the overall price level - a goal of price reductions.  He has made specific promises that the price of various and sundry goods: gasoline, groceries and utilities would decrease from their inflated, post-pandemic levels.  To be sure, the president has promised what would amount to deflation, or falling prices.  The ramifications of this is two-fold; consumer expectations and economic consequences.

Consumers would be better served by a steady dose of disinflation and slowing the growth of inflation.  The economy would be better served avoiding an across the board sustained decrease in prices; the unintended consequence of which might lead to a recession.

My sense is that consumers seem to have placed a higher value on prices actually coming down than they want inflation to slow and prices to stabilize.  In my view, they don't completely understand the consequences of these two choices; and if I had to hazard a guess it may be a result of the president's own rhetorical excess. 

Donald Trump has promised, Prices will come down.  You just watch;  They'll come down, and they'll come down fast, not only with insurance, with everything.   

He promised that: Starting on Day One, we will end inflation and make America affordable again, to bring down the prices of all goods.

Only last month the president suggested that inflation was essentially done but cautioned that he did not want actual deflation, saying this:  We don't want it to be deflation either.  You gotta be careful.  

In case your memory needs a refresh; the troubled period of time spanning The Great Recession gave us a taste of everything. 

Inflation-Disinflation-Deflation Illustrated - Data BLS

The bottom line is that since he took office Trump has begun to walk-back any number of his promises as a consequence of two incontrovertible truths.  First, price reductions are more easily said than done.  Second, broad price drops can expose the economy to self-inflicted and unintended consequences.  Moreover, with consumers smarting from rising pressures in the cost of living, Trump has begun to walk-back and delay implementation of many of his import taxes.

Where does this leave us?  Three things to watch.

The White House's unilateral use of executive authority to arbitrarily impose broad trade duties (tariffs) on imported goods has most certainly contributed to inflation.  Thus, prices for consumers and businesses have continued to increase while at the same time the rate of inflation has slowed.  Perhaps as early as Friday it is expected the Supreme Court will rule on this matter providing guidance to the administration and the rest of us going forward.

The US economy finished the year on a strong note - gross domestic product grew at a 4.3% annual rate, faster than the previous three months.  The president will try to laissez les bon temps rouler.  

I expect him to continue badgering the Fed to reduce interest rates and he'll be announcing a pick for a new Fed chair before too long.  At the same time, corporate tax cuts under the One Big Beautiful Bill will be kicking-in this year and could juice spending. Will this stimulus and tariffs goose inflation?  If so, how will the Fed respond?  

Since I lack the powers of clairvoyance my only prediction is that 2026 may shape-up to be an interesting year.  I'm sleeping very well lately; yet because we've all been to this rodeo before only time will tell.