: 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
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.
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