Government and economists say, that ideal inflation is about 2%.. why is that? Why is 2% of my savings disappearing every year good? (In ideal case)
In: Economics
A small amount of inflation incentives people to spend some money rather than just save it which stimulates the economy. 2% is believed to have enough of this effect while still allowing people to save for retirement.
Because they don’t want you to just be saving cash and you don’t either, because it’s better for both of you to have that invested in something that’s generating money or advancing us technologically.
Without inflation (or negative inflation) people don’t invest, which means there’s no capital to do capitalism things, which means there’s no economy in the first place.
It’s not so much that inflation is good (even though there are some benefits, primarily around encouraging investment rather than hoarding cash), it’s that a little deflation over a long period of time is a much worse alternative (falling wages, falling home prices, rising debt payments).
Aiming for 0% is basically an impossible goal, so aiming for a little inflation gives some cushion against deflationary pressures.
Consider the alternate case: deflation (negative inflation). Money gains value automatically, just by sitting there. Thing is? This is a *guaranteed safe investment.* You haven’t given the money to anyone, not even a bank, so it’s not possible for you to lose the money unless it’s *stolen* from you. Hence, the best investment choice quickly becomes “never spend money.” That causes the economy to grind to a halt. This can become a self-fulfilling prophecy: people stop buying, causing demand to drop, which causes prices to drop to try to make SOME kind of sale, which means the currency has deflated even more, which means demand drops, which means… etc.
Of course, the reverse direction, excessive inflation or even hyperinflation, is also very bad. That ruins the value of the currency so quickly, economic activity ceases to be relevant, and folks revert to barter economy or find other mediums of exchange instead.
However, if you keep inflation very low *but not negative*, people have a reason to invest (their money will slowly lose value if they just sit on it) without being TOO badly punished by that incentive (the money only loses value very slowly). Suddenly, everyone is spurred to invest, to seek the best employment opportunities they can get, to spend what money they need to spend *now* and to look for better returns on what money they intend to hold onto.
That’s why *small* amounts of inflation are good. They create an incentive (invest so your money doesn’t dwindle) without creating a counter penalty (it’s realistically plausible for your money to grow fast enough to exceed inflation).
Edit: Also, debt becomes SIGNIFICANTLY worse under deflation. If you owe $1000, then that means the value of your debt goes up on its own, which is then compounded by interest. That’s very bad and can lead to many defaults and other issues.
Two main reasons.
First of all getting to 0% and keeping it at exactly 0% is nearly impossible and deflation (negative inflation) is so bad that you would rather be at a slight positive at all times than risk getting into the negative.
Second of all its encourages that you use your money. That can be either spending or investing the money. Now the real target of this isnt you or someone with a few thousand $ in the bank they are pretty irrelevant to the economy. The real target are people with loads of money and even more so companies. You want companies to use their money and not just sit on it, because sitting on it means there is no more production or even a reduction in production which leads to lower employment and less goods available to the public.
Inflation isn’t really about your savings deteriorating. It’s hit or miss in the short run, but generally your wages and investment returns also inflate, so you’re really not missing out on anything.
It’s not directly good for you, but it’s good for the economy, and so indirectly good for you.
An economy is driven by people spending money. If people stops spending money, then the people who makes stuff stops making things and themselves stop spending money and it could begin a cycle of people not spending money and production of goods halting. While you could just say it’s supply and demand, the problem comes from the fact that there are certain goods that will always have demand no matter the supply, ie, food. If you suddenly became unable to afford food because you stopped getting paid, that’s bad.
Now obviously one person not buying things isn’t going to start this cycle, but if a whole bunch of people suddenly stops buying things, this cycle can start.
To try to make sure this cycle doesn’t start, the government keeps inflation at about 2%, the idea is that if you knew that 2% of your savings is effectively disappearing every year, you would want to spend that money before it does. 2% is determined to be an amount that encourages this whilst still being low enough where that amount “disappearing” from people’s savings doesn’t cause significant issues itself.
It’s less that inflation is good and more that deflation is so much worse that it’s better to manage a currency for slow, manageable inflation than risk a currency going into deflation. It also has the knock-on effect of encouraging people to invest/spend their cash rather than just sit on it, which improves the economy.
People spending money is a requirement to keep the economy running at a steady pace.
If prices stay the same or decrease over time, people will be less likely to spend money. Without revenue, businesses can’t pay their employees salaries, if employees don’t get paid, they can’t consume it, etc. Eventually, the economy will slow down and nothing will get done.
2% inflation is in the tolerable zone where central banks worry about both inflation and unemployment. There is a short-term trade off between inflation and unemployment. It’s not worth putting people out of work to get lower than 2% inflation.
When inflation is greater than 5%, central banks will fight inflation full stop even if it means putting large amounts of people out of work. The problem with this is that price increases become expected/scheduled rather than responses to the market.
When inflation is negative, loans become harder to pay off as salaries go down. People default on their loans, decreasing the portfolios of the people who made the loans. It’s a terrible cycle. Also, people start hoarding cash as an investment.
Cash should not be an investment. Cash is used to exchange goods and services, not to be a good itself. When inflation is 2% don’t hoard money itself. Invest it in something that you think will appreciate in value.
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