Regulating Inflation



The European Central Bank is regulating the inflation of the Euro. Why do they do that and why do we even have artificial inflation?

In: Economics

Inflation is artificially induced by central banks, to disincentivize holding on to money. It gets worth less, so you better spend or invest it, which boosts the economy. It also stops deflation from happening which would hinder the economy, because everybody holds on to their money as long as they can, removing it from the economy.

They do that by giving more money into circulation and setting the interest rate on their loans.

If you don’t regulate anything then you will still have inflation or deflation, it will just be uncontrolled. So instead we target a certain level of inflation as the optimal point between two bad extremes (both too much and too little inflation is bad).

It’s akin to what a dam does. Rain occurs naturally, and you can’t really control it. You get too much rain and you get flooding, you get not enough rain and you get drought. So what we do is set up a dam. The dam collects the water in a big reserve, and then it releases the water at a set rate down river so that it avoids both drought and flood. It can’t fix all problems, if you get way too much rain you would overtop the dam and still flood, and if you get too little the reservoir will go dry and you still get drought, but under normal conditions you can keep a nice predictable and acceptable amount of water flowing.

That’s what the central banks do. They use various levers on the countries economy to push inflation towards a predictable and acceptable level and try to keep it from going too far to either direction.