Biflation

What Is Biflation?

Biflation is the simultaneous occurrence of inflation and deflation in an economy. Biflation, is essentially a misnomer, since the concepts of inflation and deflation both refer to general rise or decline in all prices rather than a change in relative prices between different economic goods or asset classes. Biflation is a neologism for a type of Cantillon effect which occurs when expansionary monetary policy is applied to alleviate a recession.

Understanding Biflation

Biflation, a relatively new term coined in 2003 by Dr. F. Osborne Brown, a senior financial analyst for the Phoenix Investment Group, generally kicks in when central banks open up the monetary spigots in a bid to stimulate a stagnated economy. Because the terms inflation and deflation refer to general, economy wide changes in price, the name of the term biflation is somewhat misleading because it does not necessarily involve any increase or decrease in the general price level, but refers to change in relative prices driven by changes in the supply of money and credit in different markets. It describes a kind of Cantillon effect that happens when expansionary monetary policy during a recession results in rampant demand for commodity assets leads their prices to rise at the same time that debt-based assets are falling in value. 

A Cantillon effect is a change in relative prices resulting from a change in money supply, which was first described by 18th-century economist Richard Cantillon. Making lots of cheap money available via banks does not automatically mean that demand for everything will rise simultaneously. Instead, history shows that certain assets take favor over others, leading to rising in some areas of the economy and falling prices in others. 

Because money added to the economy (through lending and asset purchases by the central bank) or removed from the economy (through debt write-downs and liquidations) happen at specific points in the economy rather than in all markets simultaneously, both inflation and deflation tend to occur as processes over time with differential and sequential changes in prices in different markets. The resulting relative price changes that occur may confuse observers over whether the economy is undergoing overall inflation or deflation. 

Biflation is a specific type of Cantillon effect. It happens when during a period of debt deflation (and resulting recession) the central bank pumps money into the economy in an attempt to reinflate asset prices. However, despite the central bank’s efforts, the recipients of the newly created money use it to purchase commodities and related assets rather than to try and fight the ongoing deflationary trend in debt markets. The central bank’s effort to stimulate the can not only fail, but instead can result in a rise in the cost of cost of living as prices of raw materials and consumer staples may rise, similar to the effects of stagflation.

In a depressed economy, demand for raw materials used to make things such as energy, clothing, and food will likely remain relatively high because they are deemed essential purchases by consumers. People will often continue to buy them regardless of prices rises, leaving consumers with less money for discretionary expenses.

Leveraged assets like real estate are susceptible to experiencing price decreases in such an environment. When economic growth is stagnant and unemployment increases, people cannot always justify buying a home or anything else that is expensive and deemed to be non-essential, even if low interest rates, a key function of increasing the money supply, make it cheaper to borrow.

The upshot of a strong appetite for certain assets and weak demand for others is biflation. Suddenly prices are rising in one part of the economy and falling in another, giving the appearance of a mixture of inflation and deflation.

Example of Biflation

Unprecedented market events caused biflation to occur in the wake of the Great Recession of 2007–2009. Against a backdrop of high unemployment and a moribund housing sector, the Federal Reserve unleashed trillions of dollars in monetary stimulus to jump-start the economy, while pledging to keep interest rates low.

To be sure, those measures aided parts of the economy, albeit not immediately across the board. Rather than targeting the funding toward renewed lending to distressed businesses, for instance, banks and Wall Street institutions who received the new money first held much of the funding as cash or directed it into speculative asset classes. Housing prices eventually recovered, but not nearly as quickly as liquid assets, such as stocks, which attracted investors due to a recovery in corporate earnings fueled by low interest rates.

The economy saw ongoing decline in sectors such as housing prices, which fell in many regions until early 2012. Conversely, prices for gasoline rose from 2009 through 2012. The price of gold rose dramatically between 2009 and 2011, with growth slowing in 2012. Similarly, many other commodities markets saw rising prices over roughly the same period.

Special Considerations

Biflation has, in many ways, been exacerbated by globalization. In fact, following the great recession, many of the assets that experienced strong demand and inflation were those that trade globally.

For example, rampant appetite for energy and metals from rapidly industrializing countries, such as India and China, was largely responsible for boosting prices for many commodities in the years immediately following the Great Recession. This made essential raw materials more expensive in a period when many consumers in the Western world found themselves in dire straits financially, contributing to a dearth of demand for things bought on credit back home, such as homes and automobiles.