If inflation lowers demand, would that not eventually offset inflation naturally without government intervention?
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As long as the government is collecting taxes, spending money and making policy there is government intervention.
Inflation becomes a vicious cycle when most workers see prices go up and then ask and receive wage increases. Prices go up, workers ask for raises. Companies grant the raises because they are selling their products for higher prices. Now it costs more in labor to make their products, so they raise prices again. Workers then ask for more raises. This cycle can only be broken by throwing cold water on demand through the central bank increasing interest rates.
This question reminds me of the famous Keynes quote –
>The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.
Inflation doesn’t lower “demand” so much as it lowers the “movement” of a product or the “sales” of a service.
So, people still need/want the good/service but are just waiting until the prices come down. Which probably will cause the prices to inflate again.
That’s one of the possible outcome but people might also start using a different currency instead (e.g. what happened to Venezuela and Turkey).
At the end of the day, governments don’t want to lose control of their currency, as they would no longer be able to influence the economy with fiscal policy.
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.
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.
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.
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)
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.
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