Disinflation is a term meaning a decline in the rate of price increases. If prices one year increased at an average of 5 percent and the next year increased at a rate of 2.5 percent, disinflation would be taking place. In other words, it is a drop in inflation.
Though many have trouble understanding the difference between disinflation and deflation, the two are very separable and very distinct. With disinflation, price increases are still taking place, albeit at a lower rate. With deflation, prices are actually decreasing. This is the simplest way to explain the difference between the two.
Disinflation often takes place during a recession and is therefore harmful to the overall economy. In these cases, the higher costs of doing business are often absorbed by the company in order to continue moving product. At some point, this may either cause the company to go bankrupt or force a price increase on the consumer. This could lead to a further decrease in purchasing and thus cause a continued contraction in economic output.
In some cases, however, disinflation can be welcomed sign that hyperinflation is finally starting to ebb. If this is the case, disinflation can actually signal a new time of stability, after a time of double digit price increases. This reduction in inflation is generally considered by economists to be a positive development as it usually comes after a very tumultuous economic time for the residents of a particular country.
In some cases, a country's monetary policy may be specifically trying to produce a disinflation situation. This is true especially if leaders are worried about the possibility in inflation getting out of hand. The most common way to produce disinflation is to raise interest rates. This makes money harder to get through borrowing and thus increases the value of the currency. With this being the case, the relative value of the money begins to increase and is therefore capable of buying more products. In general, the goal is to encourage disinflation to the point where inflation is at a healthy rate, which is generally from 3 to 4 percent, but depends on a number of factors.
While trying to achieve this, countries must be careful to avoid deflation, which is a risk when trying to produce disinflation. In this case, it can be quite harmful for the economy. Quickly falling prices could signal lower earnings not only for individual companies, but also for the individuals who depend on those companies for jobs and who help keep the economy growing through their own personal spending and borrowing.