Inflation refers to the annual percentage rise in the general prices of all goods and services and consequent fall of the purchasing power of money. Inflation implies you can buy only a smaller percentage of the same good/service with a dollar. The central banks of countries control inflation at the safe level of 2 to 3 per cent by tightening monetary policy and raising interest rates. Deflation, the opposite of inflation, is marked by falling prices. Deflation causes low demand, unemployment and economic depression.
Demand-pull inflation is when there is a rise in product prices because demand exceeds supply. It is the shortages of production capacities that make too much money chase very little goods. Natural disasters cause supply shocks and decline agricultural crop output. This translates into temporary excess demand for food, cattle feed, dairy, poultry and other foods so prices increase. The output of industries dependent on agricultural input also falls leading to unanticipated demand-pull inflation for industrial goods. Hurricane Katrina, which tore apart New Orleans in 2005 and Hurricane Ike of 2008 caused inflation in gasoline, diesel and jet fuel prices.
Companies are forced to hike goods and service prices to ensure they get sufficient profit margins after productions costs, which include rising wages, taxes and import duties. This is cost-push inflation. Natural disasters can trigger cost push unanticipated inflation when they raise prices of input. For instance, after Hurricane Ike directly hit the critical Texas oil refineries in 2008, heating oil prices spiralled upward, pushing up production costs for oil input dependent industries.
Lower Money Supply and Credit
High interest rates and a tight monetary policy lower money supply and credit availability, causing economic deflation, financial crisis and recession if the nation has surplus production capacities. Bangladesh, a country following a tight monetary policy for two years prior to the affliction of natural disasters of floods and cyclones in 2008, was forced to loosen its monetary policy to uplift the country from the disaster's consequences of economic slump. Continuing with the low money supply would have aggravated deflation and recessionary conditions that are part and parcel of a calamity strike.
Decline in Government, Investment and Personal spending
Natural disasters entail huge government expenditure for reconstruction causing budgetary deficits. The government becomes cash strapped and is hence forced to restrict spending and this can contribute to deflation and recession of the economy already reeling from the other repercussions of the disaster like unemployment and poor trade. This has been experienced in the Maldives, which was struck by a Tsunami in 2004 December.
Natural disasters like disease pandemics cause supply-side disruptions. High levels of illness and death can translate into labour absenteeism and production scarcity. Consumer spending contracts causing fall in demand and investment. Thus economic activity falls and deflation or price fall ensues. Sectors worst hit are generally tourism and exports. Asset prices decline causing asset deflation due to preference for liquid cash. The 1918 Spanish flu epidemic in the US and the Avian flu pandemic in the US in 1968 and 2006 are examples of natural disasters that caused deflation. Some natural disasters like floods and earthquakes severely hamper trade and exports creating short-lived deflationary situations.
- IMF: Deflation: Determinants, Risks, and Policy Options--- Findings of an Interdepartmental Task Force 1 (page 15)
- SBA.LUC: U.S. Inflation and Commodity Prices: Analytical and Empirical Issues (Pages 5 and 6)
- IMF: INTERNATIONAL MONETARY FUND (Pages 2, 3 and 4)
- Investopedia: Inflation
- Investopedia: Deflation
- China Daily: Are we staring at inflation? Read on to find it out