Inflation and Deflation – How Do They Affect Currency Fluctuations?

Economic trends, monetary policy and currency fluctuations are all critical variables in the Forex trading formula. The impact of inflation or deflation on the money supply impacts the purchasing power of money, and the wealth of currency holders. Because of that, it’s crucial to understand the differences between inflation and deflation when trading currencies.

Inflation, or an inflationary trend, is characterized by a general rise in prices within an economy. The direct purchasing power of currency is devalued at the rate of inflation. The United States government measures the rate of inflation, or deflation, by various means including the Consumer Price Index (CPI). The US government, via the Federal Reserve, attempts to influence the purchasing power of money with monetary policy. The negative effects of inflation can be devastating. Savings can be wiped out and people can hoard tangible goods to hedge against the devaluation of money.

Deflation is characterized by a general decrease in prices within an economy. The direct purchasing power of currency is increased at the rate of deflation. The government measures deflation and attempts to influence it through monetary policy, in much the same way as inflation except the steps taken will be the inverse. The negative effects of deflation can include reduced lending and spending of cash. This in turn has larger macroeconomic impacts and can lead to recession or depression. Deflation can lead to the hoarding of currency and restrict or inhibit global economic trade.

Inflation and deflation can also have positive effects. Debt burdens are greatly reduced by rapid inflation. Inflation is believed, by some experts, to reduce the effects of recessions. On the other hand, deflation can be used as a tactic to stop rapid inflation. Deflation also benefits those receiving fixed income and will greatly enhance the purchasing power of currency holders. Understanding inflation and deflation can lead to informed currency trading and increased returns for Forex currency traders.

The government, through its many agencies, is an excellent resource for tracking economic trends critical to currency valuation. Traders will benefit from monitoring the actions of the US Federal Reserve, and central banks around the globe. Overall, inflation and deflation really do play a pivotal role in the value of currencies around the world.