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
Money is designed to be circulated into the economy. You buy something and it pays the owner who pays staff, suppliers, utilities etc
If inflation is at 2%, it’s worth less tomorrow so it encourages people to spend but also save some
Saving in a regular account is good because it’s liquid and you can use it easily when you need to.
To beat inflation, you want to invest in things to bring you more return. This means more money is pumped into businesses to expand, create more jobs, who can spend money into the economy
A low rate also encourages businesses to borrow which boosts the economy for the above reasons
Now if it’s 0 or negative, it encourages people to do the opposite. Why spend today when it’s worth more tomorrow? If nobody is spending money, then businesses can’t afford to keep the lights on, which means people lose jobs. Industries lose investments, manufacturing declines etc
If it’s too high, people can’t afford non essential goods and investments. If the price of goods is high, people want higher wages which means the business cant afford to hire more people so they cut back
It also affects the international economy with imports and exports as it affects the prices other countries pay
It’s very complex and these examples are not guaranteed to occur, but it’s the general idea and known examples of what has happened
One thing I don’t see mentioned here is that inflation decreases an individual’s debt (assuming wages increase). The total debt you owe, in real dollars, decreases every year.
There are other things to consider as well with exports and the value of one currency against another.
Inflation is also partially responsible for the creation of increased wealth. If GDP (and other metrics) outpace inflation, that’s the literal definition of creating new wealth. How the wealth is distributed in an economy, well that’s another matter entirely.
Other people have covered it pretty well. Something else to think about is that one thing that causes inflation is the government creating more money. As the government prints and distributes money, there’s more money in the system, causing everyone’s money to become less valuable. That *can* be a good thing, if the government uses that money to invest in infrastructure and public services: rather than needing to run the government as a for-profit business, the government can ensure it has the money it needs to provide vital services. And that’s on top of mild inflation encouraging people to spend and invest, both healthy things for an economy.
There’s no guarantee a government will spend its money well, of course, but it’s a potentially good thing that would cause inflation.
Inflation is caused by too many buyers chasing after too little goods, indicating that our economy is not producing enough goods to keep up with demand.
Deflation is caused by too many goods with not enough buyers, indicating that our economy has outpaced demand. Shrinking demand indicates the country is in decline as people are unable to afford new goods.
Too much of either is a very bad thing. In an ideal economy, demand for goods just slightly outpaces production, causing business owners and investors to put money into the business to grow to meet demand. Causing a steady increase over time. If this difference is small enough, say 2%, wages, employment, demand and production are all able to keep up with each other (mostly). When the gap becomes too large, we run into situations like we are in now, where price hikes are massive, so wage hikes have to be massive to keep up.
Think of it like a wrecking ball on the end of a crane. If the ball swings in tiny little motions (small inflation), the building doesn’t take much damage. The further back the ball swings, the more damage is inflicted (increasingly larger inflation).
The economy and the country needs to grow. More people = more money, and the side effect is that the money ends up being worth a little less.
The alternative is stagnation or deflation, both of which are bad because it means people spend less, which means businesses can’t grow, which means they can’t hire, which means job losses and recessions.
2% is a myth.
Started off as positive inflation no more than 2% being a goal for the NZ central bank, no more than 2% because of inherent inaccuracies in consumer price indexes for a small island nation.
Then got copied around.
Deflation is generally seen as bad, mostly for historical reasons, as solving deflation while on the gold standard was very hard. And governments were forced to hike taxes, or get rid of the gold standard, worsening economic issues. In the modern day it’s still bad but to a lesser extent as money can be freely printed to solve it.
Deflation, in absence of any intervention is usually caused by an economic slowdown and inflation a result of economic growth and an expansion of credit markets. Changing inflation rates has some effects on the economy, lowering inflation will generally cause a lowering in growth, increasing inflation will generally increase it, but this relationship is not as solid as the impact of growth on inflation.
Inflation is good for homeowners with mortgages as long as compensation keeps pace. What is 50% of your income slowly becomes less than 20% by the time the home is paid off.
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