Reflation
Reflation is fiscal or monetary policy aimed at lifting economic activity and pushing prices back up after a slump or period of deflation. The "reflation trade" refers to investments expected to benefit, such as cyclical stocks, commodities and higher bond yields.
After a recession, prices and output are often depressed. Governments and central banks then try to "reflate" the economy — cutting rates, buying bonds, spending more — to restore growth and normal inflation. Markets react in a recognisable pattern, known as the reflation trade. This entry explains reflation, the policies involved and how investors position for it.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Reflation trade, Reflationary policy
- Updated
Reflation in plain words
Reflation refers to fiscal or monetary policies meant to stimulate the economy and combat deflation.1
During contractions, weaker demand pushes firms to cut output and prices, creating deflationary pressure that reflation tries to reverse.1
When rates are already near zero, ordinary monetary easing can lose power, which is why reflation often leans on fiscal policy.2
How reflation works, step by step
A slump hits
Output and prices weaken. See Recession.
Rates are cut
Cheaper borrowing. See Rate Hike and Rate Cut.
Asset purchases
Central banks buy bonds. See Quantitative Easing and Tightening.
Fiscal stimulus
Tax cuts or spending. See Fiscal Policy.
Demand recovers
Prices and output rise.
Policy is withdrawn
Before inflation overshoots.
Worked examples
Example 1 — Prices recover
Deflation reversedInflation goes from −0.5% to 2% after a year of stimulus.
| Change | +2.5 points |
Reflation policies aim to lift activity and combat deflation.1
Example 2 — The reflation trade
Risk-on rotationOver six months, cyclical stocks gain 25%, copper 20%, and long bond prices fall 8%.
| Cyclicals | +25% |
| Copper | +20% |
| Long bonds | −8% |
Expectations of stronger growth and inflation lift risk assets and push yields up. See Cyclical and Defensive Stocks.
Example 3 — Overshoot
Inflation problemStimulus stays in place too long; inflation rises to 6%.
| Target | 2% |
| Overshoot | +4 points |
If reflation goes too far, it becomes inflation, and policy must tighten. See Inflation.
Reflation vs inflation vs disinflation
| Aspect | Meaning | Typical cause |
|---|---|---|
| Reflation | Prices recover from a slump | Deliberate stimulus |
| Inflation | General price rises | Demand or cost pressures |
| Disinflation | Inflation slows | Tighter policy |
| Deflation | Prices fall | Weak demand |
How investors trade reflation
Cyclical stocks
Banks, industrials, materials. See Stock Market Sectors.
Commodities
Rising demand lifts prices. See Commodities.
Short duration bonds
Avoiding falling bond prices. See Yield Curve.
Inflation hedges
Protecting real value. See Inflation Hedge.
Advantages and disadvantages
Advantages
- Helps economies escape slumps.
- Restores healthy inflation.
- Creates clear market themes.
Disadvantages
- Risk of overshooting into inflation.
- Fiscal stimulus adds debt.
- Timing the exit is difficult.
Going deeper
Read as far as you need. Each level builds on the one before it.
Why deflation is feared
Beginner
Falling prices can make people delay purchases and raise the real burden of debt, deepening slumps. See Depression.
Policy toolkit
Intermediate
Reflation can use fiscal measures, monetary measures or both.1 See Fiscal Policy.
Zero-rate constraint
Advanced
Near zero rates, monetary policy can become ineffective — a liquidity trap — making fiscal reflation more important.2 See Liquidity Trap.
Common mistakes
Confusing reflation with inflation
Reflation starts from depressed prices.
Chasing late
The trade often moves early.
Ignoring policy exit
Tightening ends the trade.
Holding long bonds
Rising yields hurt them.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Reflation aims to restore growth and prices after a slump.
- It uses fiscal and monetary stimulus.
- It counters deflation.
- The reflation trade favours cyclicals and commodities.
- Overshooting leads to inflation.
Frequently asked questions
Is reflation good for stocks?
How is reflation different from inflation?
What ends a reflation trade?
Further learning
- Liquidity Trap
When monetary stimulus stalls.
- Quantitative Easing and Tightening
Central bank bond buying.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Reflation (opens in a new tab) Checked .
- Corporate Finance Institute. Liquidity Trap (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.