: Why is (consistent and steady) inflation considered to be a good thing? We hear about rising wages chasing the rising cost of living, and we do this calc every time we look at historical prices, so why is this better than static prices? Is it all driven by TVM?
In: Economics
We want a little nudge to buy today for fear that prices might go higher in the future. And we want a nudge to save money in banks or invest money vs. stuffing it under the mattress or in a safe, allowing that capital to be available for loans and business investment.
A stable low level of inflation is a good thing because deflation is disastrous.
Deflation = an overall decrease in prices. If consumers expect that prices will continue to fall, then they prefer to save to buy goods and services later when they are cheaper. This decreases demand.
As demand decreases, producers are unable to sell as much and therefore reduce supply, reducing their need for factors of production, such as labor, increasing unemployment.
As unemployment increases, consumers’ income decreases, further driving down demand (and prices), perpetuating a deflationary spiral.
Deflationary spirals have been attributed to significant economic events in the past, such as bank runs and the Great Depression, which is why it’s preferential to have low levels of inflation and prevent deflation.
Two reasons. First, the people who make monetary policy don’t just get to pick inflation. They “target” it, and sometimes that targeting doesn’t work. If target inflation is 0, then sometimes you get deflation, which can be quite damaging to the economy because it strongly discourages spending.
Second, a target of 0 inflation would require quite strict monetary policy. Fighting this recent bout of inflation has required restrictions that make it harder for people to borrow money -not just businesses and banks but also home buyers and other individual borrowers. Targeting zero inflation would crank this up even higher and make it permanent.
Deflation is really bad. Devastatingly awful bad.
If your target is 0% inflation, there still will be inflation in somethings. Healthcare and college for example have had higher than average inflation over the last few decades. To balance out to zero, this would mean everything else would have to be deflationary, which would be really bad.
Also, people’s wages tend to go up over time in rich countries. A taxi driver in New York City charges more than a taxi driver in Bangladesh, because the taxi driver in NYC could easily find a job in construction making more in a week than a worker in Bangladesh makes in months. Keeping inflation zero while wages go up would be super challenging and would hurt economic growth.
It doesn’t make sense. I wish I read more about Austrian economics when I was younger.
https://mises.org/mises-daily/inflation
People make doom and gloom arguments about deflation, and I disagree. Sure, it would knock out coompanies who make useless items that people don’t find valuable, but no one will hoard all their money and stop purchasing things they need like food, gas, cars, games, phones, etc..
Technology is already deflationary. Last year’s iPhone is about half the price of the new one, but they still sell out of the new ones every release. Same goes for computers, tvs, and any tech. If deflation is so bad, why are tech companies still profitable? Why do most people in America always have the latest and greatest tech? Based off how people act with recreational items, we think they would not buy items they need to live and enjoy life? Deflationary death spirals are BS.
Currency is just a way to trade wealth, wealth is anything human value like resources, products and services. In general wealth tend to increase over time, we have more people to create wealth, our technology make us produce more wealth, etc.
There is a supply and demand relationship between currency and wealth. The wealth is the demand because the more wealth you have the more you want to trade it for other type of wealth, and currency is the supply because you need currency to trade wealth.
So if the demand (wealth) increase over time, but your supply (currency) stay the same, the value of your supply will increase. That’s called deflation and it’s bad long term for the economy. The reason is that it become more profitable to keep your currency to yourself instead of investing it, which in turn mean less currency moving around in the economy and less economic growth.
We are talking about the economy of a country, it’s very complicated and so it’s impossible to add to the economy the exact right amount of new currency to keep the inflation/deflation to zero. If we would target 0% we would sometime get inflation to 2%, sometime deflation to 2% and it’s not ideal for economic growth. Big inflation is also not good since people lose too much purchasing power and the economy don’t have the time to balance out by giving higher wages.
2% is viewed as the best target for inflation because it’s small enough that the economic have time to adapt while still being enough inflation to incentivize people to invest their money. You know the whole, you are better investing your money rather than keep it all in your bank account. So this help with economic growth. The other advantage is that since we can’t be perfect in general the inflation will vary from 0% to 4% if you target 2%.
Now of course this is the theory behind it, some government are always tempted to overuse the short term solution of adding too much new currency to pay what they need now and that drive the inflation higher than your standard variation. There is also the problem of unbalance in an economy where most of the economic growth goes to the richest which mean the economy never really balance out with inflation. But those are separate problems.
Eli5 – because it makes people do something with their money rather than sit on it.
If money was more valuable just by sitting in a bank account, people would do that and money wouldn’t flow. Instead, it loses value by sitting. So, to avoid that, people invest (in theory) which makes the economy grow (also in theory).
Eli 18 -The thought is that inflation is fine if the economy grows faster than inflation. Now, that theory assumes that everything in the economy would also grow to meet or exceed inflation, including wages. Except since the late 70s, wages have not kept up.
This is great for companies since they adjust prices regularly to beat inflation. If they don’t adjust salaries, they get an extra % to put in their pockets, which is what they did. We are now approaching the stress point of those assumptions.
One other wrinkle is that the assumption is a little stressed by the prevalence of whats called non-productive assets. Things like real estate and stocks dont really create anything (at least for stocks after IPO anyway), compared to factories or machinery or businesses. This confuses the issue and makes the “economy” look great, when its just money producing money and not (arguably) anything of real value.
When money is producing money, this accelerates inflation and is destructive to markets because the money holders can flood out poorer market participants for goods and services. This is why we are seeing a lot ofventures like Uber, who are not profitable and are losing money on pretty much every ride in exchange for starving out their competitors. In a monetary battle of attrition, the poorer participant loses.
Remember, though they changed the definition of inflation to refer to rising prices. Make no mistake, inflation is increase of the money supply. Rising prices are a symptom.
To understand why we need to go back to the nature of money.
Remember that money itself should not be valuable. What’s valuable are the goods and services that we can trade for using money.
Money is really just a unit of information used for trade, like the ones and zeros in your computer.
Our economy only works because we trade goods and services. If everyone just holds on to money, and not move the signal along, the trading slows down, and the real wealth we have starts to decay.
So, you want to penalize people for holding onto money, just enough that there’s some impetus to put it to work.
In addition to all above good answers a small amount of inflation lubricates small adjustments in pay and cost of goods adjustments.
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