Being Economical
Let's be economical with words. Let's understand the basics of inflation, deflation, and stagflation, with a simple extended metaphor.
First, let's start with the equilibrium. Equilibrium is when the value of both sides is equal. Suppose there are 2 boys and 2 girls. The value of liquidity and commodities is in equilibrium, thus normal.
Now, let's suppose that due to some events, the balance is disturbed. Let's bring 2 more boys into the equation. Now there are 4 boys and 2 girls. Now, 4 boys have to compete for 2 girls. This competition drives the price of the girls higher, and they become expensive. Boys become cheaper because their availability is more than their necessity. In economics, this imbalance causes woes.
This is the problem of plenty. The circulation of boys into the ecosystem is more than the availability of girls. How can we solve this problem? We have to remove 2 boys to control the situation. That's why the interest rate is raised. When the interest rate rises, deposits increase. When deposits increase, currency circulation slows. In other words, the problem of plenty (money-money-everywhere-situation) causes economic imbalance. It's called inflation, and the problem is neutralized by removing the amount of money in circulation.
That's inflation.
What's a recession, then? It's just the opposite! Suppose there were 2 boys and 2 girls. But somehow the equilibrium got disturbed, and the equation changed. Now, we have 2 boys (money) and 4 girls.
In this situation, girls' value depreciates and boys' value rises. This disturbs the balance. People tend to spend less when they have less money, and the value of the commodity decreases since people don't have enough money to buy goods and services. This causes economic woes again.
How can we solve this problem? By supplying more money to the ecosystem. In this analogy, we have to bring 2 more boys to strike a balance.
Stagflation is the juxtaposition of both. This occurs when both scenarios co-occur. Sometimes we have fewer boys, and sometimes we have fewer girls. It happens together as if by magic. To resolve this situation, policymakers combine both of the approaches above.
In other words, when you are too happy, you shed tears. Inflation is the tears of joy. You have more resources at your disposal. Conversely, recession is the tears of sadness, when you have fewer resources. And, stagflation means a mixed situation when one eye sheds tears of joy and another, tears of sorrow, both at the same time.
Two laws of economics:
When you have more money, you tend to spend more, causing the value of the other variable (girls) to increase. To curb that imbalance, we need to remove the circulation of money.
Oppositely, when we have less money in circulation -- less employment, etc. -- we have to inject more money (adding 2 more boys in our second analogy).
This is called the basics of economics, and those who find ways to balance these basic equations are called economists.
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