Inflation and Deflation: Which is More Likely to Trigger a Financial Crisis?

Frankly speaking, neither of these is good, but if forced to choose, deflation is generally considered the one more likely to trigger a systemic financial crisis.

We can think of these two as different illnesses.

First, Inflation: Like a High Fever

Inflation can be simply understood as "money losing its value." The money in your hand might buy a certain amount of goods today, but less of it later.

• Its Manifestation: Sustained price increases, and the purchasing power of your savings shrinks.
• Why It Happens: Usually, there's too much money in circulation, but the quantity of goods and services hasn't kept up.
• Its Impact:
  • Mild Inflation (e.g., 2%-3% annually): Is actually an economic "lubricant." It makes you feel that money sitting idle will "spoil," so you're more willing to spend and invest, which stimulates economic growth.
  • Severe Inflation: Is like a high fever, making people very uncomfortable. Especially those living on fixed wages and pensions will find life increasingly difficult.
  • Hyperinflation: That's an ICU-level crisis, where money becomes worthless paper, and the entire social and economic order collapses. However, this usually occurs in extreme situations like war or government credit collapse.

For central banks, the "cure" for inflation is relatively clear, such as raising interest rates, tightening monetary policy, etc., much like giving "fever reducers" to a patient with a fever. Although the process can be painful, the path is clear.

Next, Deflation: Like Having Anorexia

Deflation, on the contrary, means "money becomes more valuable." Today, your money might buy a certain amount of goods, but later it could buy more. Sounds great, right? But for the entire economy, it's a huge trap.

• Its Manifestation: Sustained price decreases, and everyone is unwilling to spend.
• Why It Happens: Usually, there's too little money in circulation, or people are pessimistic about the future, so no one dares to consume or invest.
• Its Danger (and the key to triggering a financial crisis): It triggers a "death spiral."

This "death spiral" works as follows:

1. Prices Fall → Consumers Hold onto Cash and Wait

   • If you find out a car will be cheaper next month, you definitely won't buy it this month. If everyone thinks this way, consumption across society grinds to a halt.

2. Consumption Stagnation → Corporate Profits Decline, Leading to Layoffs and Pay Cuts

   • Goods can't be sold, factories and companies can't make money, so to survive, they can only lay off workers and cut salaries.

3. Layoffs and Pay Cuts → People's Incomes Decrease, Making Them Even More Reluctant to Spend

   • People lose jobs or have their salaries cut, becoming more pessimistic about the future, so they tighten their belts, and consumption further shrinks.

4. Consumption Shrinks → Prices Continue to Fall...

   • This forms a vicious cycle, where the entire economy is like falling into quicksand, sinking deeper and deeper.

The most fatal blow is here:

• Debt Crisis Erupts: In a deflationary environment, your income decreases, but your debts (e.g., mortgage, car loan) remain fixed. Suppose your monthly salary is $10,000, and your monthly payment is $5,000. With deflation, your salary might drop to $8,000, but your monthly payment is still $5,000. Your debt burden "realistically" increases. When more and more individuals and businesses cannot repay their loans, banks will face a large number of bad debts, nearing collapse. Once banks are in trouble, the entire financial system could collapse. This was the classic scenario of the 1929 Great Depression in the United States.

For central banks, the "cure" for deflation is very limited. Lowering interest rates? Possible, but there's no room left once it hits zero (zero lower bound). Directly giving money to people (quantitative easing)? If people are afraid and dare not spend, the money merely transfers from the central bank's account to commercial banks' accounts, still unable to stimulate the economy. It's like trying to feed a patient with "anorexia"; you put food in front of them, but they just won't eat, and it's hard to force-feed them.

Conclusion

So, while both are illnesses, deflation, due to its self-reinforcing spiral effect and fatal blow to the debt system, is generally considered more likely to trigger a comprehensive and difficult-to-escape financial crisis. Economists widely agree that a world with mild inflation is much safer than one with deflation.