I’ve read that many banks want a certain level of inflation and I don’t really see why. Why is important to banks that a stable product costs more tomorrow than today?
Is it to make people spend their money more since storing it will eventually make is worth less?
In: Economics
It’s not, really, not universally. Whether it’s desired or not depends on the nature of your income.
Policy makers will tell you that inflation is important to promote spending, but this is false. It has nothing to do with promoting spending, versus savings. This is because if all you wanted to do was save money, there are non-cash vehicles you can put your money into, and even if the inflation rate were *zero*, you would still be better rewarded by putting your money into an asset which yielded you returns on your investment than simply stuffing your stable cash into a mattress.
This is why the price of gold drops when the economy starts to pick up. Gold is perceived as having stable value in bad economic times (and all value is really perception. Without a buyer, a price is a wish). As opportunities for greater returns arise, people will dump gold, and buy those assets.
The actual function of inflation is to give your society’s workers a pay cut, without telling them, they’re getting a pay cut. Here’s a pertinent quote by John Maynard Keynes, one of the most influential economists of the 20th century (and an advocate of the moderate inflationary policies we see today):
>Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.
So, as inflation increases, wages, rents, and loans become gradually less expensive over time. If you’re a wage-earner, lender, or landlord, this is bad news, because the buying power of your income is persistently sapped away. By contrast, if you’re an employer, renter, or borrower, the effects of inflation can redound to your benefit. In practice, the stable inflation system is factored in by sophisticated economic actors, and overlooked by those who don’t understand the mechanism and its effects.
However, one thing you must understand about monetary policy is that it is a very imprecise instrument. The ability of central banks to control consumer spending trends or business plans is incredibly limited and unpredictable. While it’s not correct to say these institutions have *no* effect, the efficacy of their policies is quite suspect, and frequently disputed. What is **NOT** disputed, however, is that while moderate inflation is relatively innocuous for an economy, **DEFLATION** is catastrophic.
Picture a scenario where the longer you sit on you paycheck, the more you can buy for it. Now imagine that everyone is aware of the dynamic, and so the entire economy is busy hoarding cash, in anticipation of some future day where their money is worth more and more. The result of this condition will be that suddenly everyone’s income stream dries up. Stores no longer sell products, and they must now cut staff. Staff no longer receive paychecks, and so they can no longer make rent. Landlords no longer collect rents, so they must cut pack personal spending, you swiftly have a vicious cycle where the reciprocal engine of commerce seizes up.
So, the real reason the Federal Reserve has a stated 2% inflation target is actually to ensure that, given the lack of predictability of their rate changes, we never dip into deflation, triggering a huge economic contraction.
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