Reflation explained: What does it mean for consumers?

Reflation can be thought of as an upswing of the economic cycle where both growth and inflation are increasing, typically after a deflationary period or recession. The pandemic crisis of 2020 was a classic case of a deflation where economic growth rates fell and economies were shuttered, due to the shock, the stock prices of companies plunged. What we saw next was policymakers across several world governments swiftly coming to the rescue with zero-interest-rate policies, huge liquidity injections and large fiscal stimuli measures. There was an immediate upswing in the market which left many bottom-up investors in shock and awe asking why would markets do so well when economic conditions are bad, but much of this occurred in response to reflationary trends. 

How does it work? 

The economic life cycle follows a certain pattern. It starts when more jobs are introduced in the market and employers must compete for the best job candidates, so they begin to increase compensation packages. Higher wage costs incurred result in those companies increasing the prices of the goods and services they produce. Higher prices mean the next phase has kicked in - inflation. When inflation rises, the central bank typically steps in and raises interest rates. The rise of interest rates makes it more expensive to borrow money and this results in a slowdown of growth and rate of price increases. 

Reflation is that period of gradual price increase when an economy is striving to achieve full employment and growth with the interest rates still on the lower side. During this period, it is cheaper to borrow money and less rewarding to stow capital away in a savings account, encouraging people and businesses to spend more freely. 

Many economists refer to reflation as ‘controlled inflation’. For the average consumer, reflation is considered good, and inflation bad. Reflation is considered to be a good period for wages, profits, and risk assets as demand drive prices and profits higher. On the other hand, inflation is a condition wherein our money buys less today than it would yesterday. This results in a lower standard of living and lower disposable income. 

Both reflation and inflation lead to price increases, but they are done for very different reasons and have different outcomes for investors. It is seen that commodity stocks, bank stocks and value stocks tend to be reflationary winners. In addition, cyclical sectors such as energy, resources, financials, consumer discretionary and technology do well during reflationary times.