If inflation lowers demand, would that not eventually offset inflation naturally without government intervention?
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Some demands are more “elastic” than others.
Vacation homes? Highly elastic demand that swells in good economic times and shrivels in downturns.
Food? Highly inelastic demand. You won’t last long without that.
This makes the impact of inflation highly variable depending on what industry you’re in and how much money you make. Kraft and Ferrari don’t sit on the same demand curves.
The problem is inflation affects everything…but you can’t lower demand for some things. Sure, if inflation only affected designer handbags, lowered demand would eventually reduce inflation to a stable position.
But when it also affects eggs and bread…well you can’t exactly eat nothing for long enough to slow inflation.
It could. Inflation raises prices. When prices rise, demand for products tends to decrease. Demand for some products doesn’t change much based on price though, since people need those things to live. Examples of those kinds of things are food or gas. Demand for other products does drop a lot when prices rise. Those things include luxury items or designer clothes. However, even necessary products like gas can be impacted by prices, but usually that’s over a longer timeframe. If gas prices stay high long enough, people might drive less, take public transportation more, or switch to cars that don’t use as much (or any) gas. As that demand reduces, the prices tend to drop. In theory, people could start living entirely on ground wheat and water, move into low cost housing, and ride bikes to work. But dramatic changes in behavior leads to industries that employ a lot of people having to lay people off. And price increases that cause people to struggle paying for necessities can cause civil unrest. So governments try to dampen the impact from inflation, and keep inflation to a much lower level than what is happening currently in the United States. They do this primarily by controlling how much money is flowing through the economy in the form of setting interest rates that banks can borrow at. Raising the rate makes the cost of borrowing money higher, which reduces the amount of money in the market and tends to push prices lower or slow inflation. Lowering interest rates makes borrowing cheaper, increasing the flow of money and pushing prices up.
It would, provided that employers can resist higher wage demands that usually accompany inflation. The problem with that is not only that it may make a lot of people feel poorer and upset, it can also lead to overall lower economic output. If people feel poorer and buy less, then companies will also make less than they could in theory given their capacity. If you assume that the things that companies make are generally “good things” then them making less than they could would be a “bad thing”. It’s ultimately the amount of goods and services produced that constitute a nation’s “wealth”, so letting inflation self correct does go hand-in-hand with people on average feeling poorer and arguably being poorer than they might otherwise have been. To some extent this is perhaps unavoidable, but there is a danger. Reduced demand -> reduced output -> more unemployment -> more reduced demand -> … . You could get a downward spiral leading to a great recession. Government interventions try to make sure this spiral doesn’t run down too much, but need to tread carefully. Increase money supply too much and inflation gets worse and you don’t fix the problem. Decrease money supply too quickly and unemployment rises very quickly and you could get a downward spiral that leads to unrest.
It depends on how inflation is caused. Because a supply line was cut? Because the government is printing money?
It very much depends on what is driving price rises. If it’s monetary supply, then that’s a result of government intervention, and so a corresponding government intervention (raising rates) is the main lever to address it.
But if it’s not monetary supply – if instead it’s due to short-term geopolitical events and/or shocks exposing structural failures in the economy itself, then what raising rates accomplishes is it lowers the ability of those most impacted by higher prices to seek credit to support their higher expenditures.
One of these scenarios hits primarily at the top of the income distribution, while the other hits primarily at the bottom. When you hit the bottom too hard, you get recessions.
One factor I didn’t see mentioned already is one of the big factors that leads to runaway or hyper inflation. If people expect inflation it can lead to inflation.
As an example, you notice your washing machine is getting older and will need replacing soon. Prices are high so normally you would push your existing machine as long as it could go (reducing demand) to stretch your budget. But if you expect the price of washing machines to go up by 50% over the next year then you might just replace the machine today (increasing demand) and find a way to make it work. In a high inflation scenario, everyone is making these decisions on all types of purchases which forces high inflation to actually occur. This can get bad enough that people aren’t just doing this with big infrequent purchases, but instead people feel the need to immediately cash and spend their entire paycheck as soon as they get it since it is quickly losing value as soon as it hits their bank account. (This second scenario is when inflation has reached Venezuela/Weimar republic levels not just 10% a year)
People buying less in response to higher prices isn’t a decease in demand. It’s a shift along the demand curve, like so
https://qph.cf2.quoracdn.net/main-qimg-4c7fea30b91c1304b61ef22f90981e39
You’re confusing quantity demanded, which is the amount of stuff people will buy at the current market price, with demand, which is a function describing the amount of stuff people will buy at every price.
Demand has only decreased if people become less willing to purchase a good at the same price.
Inflation doesn’t lower demand, it’s the opposite. Inflation comes from increased demand due to their being more currency available than their are goods to buy with it.
Such as when people are told not to go to work, but are still paid via of newly created money. Not only did this increase demand, it also lowered the supply due to people not producing as much of the goods and services.
Probably, yes. Inflation tends to decrease when everyone is unemployed and no one is buying anything. Correcting inflation by wrecking the economy comes with significant downsides though.
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