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
The actual reason has to do with foreign exchange rates. If we owe $1 billion to another country, and the value of the US dollar decreases (inflation), then we technically owe them less money. Banks can use this to their advantage with oversees trading.
I disagree with the many people here that say inflation is a good thing unless you like losing the value of your earnings year over year. Wages are the last thing to get increased, prices increase first, and then businesses increase wages. No business owner with any sense is going to increase their overhead before their income increases. So the regular person is kept on a treadmill trying to keep up with increasing prices while slowly getting wage increases, falling ever behind. While those at the top get to keep accumulating more and more as wages lag price increases. Look around (I’m assuming you are from the US), is housing more affordable, or are people making equivalent wages to what previous generations have? The answer is no, houses cost more and people make less, that is an effect of inflation. I don’t buy the argument of inflation being good because it encourages spending, if you need food, a car, a house, or most anything other than luxury items you buy them. I’ve yet to meet anyone who buys goods based on their future value vs what they pay for it now (real estate/gold being the exception).
If you look at the time period of the 1800’s-early 1900s (a deflationary period) people still got wages increases, any money they saved gained purchasing power (cost of stuff went down). Compare that to today where saving money is losing purchasing power, while maybe the number that you receive for wages may be increasing, the value of your wages decrease.
I believe the purpose of why is so the government can spend well beyond their means, and when they have to pay back what they promise they use the inflated dollars, so someone else gets to eat the true cost. By the way that someone is you, me and retirees (2x).
Because you need to have always, constant, endless growth. I mean growth is a fundamental requirement for the current financial system, if you don’t grow it, it collapses.
Inflating things makes them grow, hence inflation is a good way to grow.
It’s mostly what you said here:
>to make people spend their money more since storing it will eventually make it worth less
But also the point of a small positive inflation is to prevent ***de****flation,* which is VERY BAD. Imagine if the buying power of money was always increasing. Sounds good at first, but think of the consequences. You can buy shoes today or a TV later. A TV today or a *car* later. A house today or a …*better* house next year. Deflation actively discourages spending, probably even more than inflation promotes spending. And it’s a runaway cycle once it starts and everyone starts hoarding cash.
If banks tried to keep inflation right at zero, there’s a chance it can slip into deflation and shit goes sideways, so they aim for small but positive inflation as a balance.
Government also wants inflation to tax the future while simultaneously devaluing their debt. But too much and people lose trust for the economy.
I wanna know the answer to this too, but going through the replies made me more confused than I was before reading them.
Grateful you asked this question, had the same thought earlier after seeing a NYT headline. Interesting that inflation is good, but wages have stagnated for so long. The rich get richer and the poor loose everything.
Mild inflation (5% or less) is relatively harmless because the vast majority of people spend the majority of their earnings relatively quickly. No one is buying groceries with the actual currency they earned in 1990. Younger people save some income and invest it. Over time the investments earn interest or increase in value because of inflation, productivity and earnings growth.
Mild inflation allows people to buy big, expensive things like houses with long term loans. Inflation makes it easier to make the payments over time. It also encourages people to buy things soon because they’re slowly getting more expensive.
Mild inflation: money is getting less valuable over the long term so you want to buy things that retain their value and/or grow over time
Deflation: money is getting more and more valuable so you want to hold on to it for as long as possible because the things you may want to buy are just getting cheaper (mostly because no one is buying stuff). Your pay is also subject to deflation along with the value of your home. Your loan balance will not change, though. This is not good
Hyperinflation: money is losing it’s value very rapidly so you want to get rid of it as soon as possible. You want to be paid every day and go to the market and buy what you need immediately because everything will be more expensive tomorrow. The problem is everyone else is doing the same thing. This is not good.
According to the classical theories, long-term GDP/GNI growth in an advanced economy should be about 3% per annum with inflation of around 1.5-2% – hence why the target range for the Federal Reserve or Bank of England is exactly that range – 1.5-2% inflation
There is much empirical evidence of how destructive DEFLATION is to an economy. Imagine economic activity is doing well in real terms with year-on-year growth in goods and services produced and sold, but the overall growth of the economy (value of those goods and services) is negative. That’s what can happen with deflation, which is a real killer. Japan has been trying to fix deflation for 40 years and counting, it still hasn’t got there, despite pioneering Modern Monetary Theory (printing to infinity)
The OP is correct in that inflation encourages spending and borrowing. If your money is going to be worth less in future, you may as well maximize your value via buying now, which increases economic activity and the velocity of money. Crucially, when BORROWING, inflation erodes the real-terms burden of repayments. If you borrowed $1 million today at 0% interest, you will effectively pay back significantly LESS than $1 million in real-terms dollar-adjusted via compounded inflationary effects. If there is deflation, you pay back significantly MORE in real terms. So you can see why those who are doing the most borrowing – our governments and banks – are on a path where inflation is not only desirable but pretty much essential. This is mirrored by consumer spending patterns and we all hope to use inflation to erode our debts.
In the most simplistic terms, inflation is good because deflation is bad. It would be possible to have 0% inflation but this is not congruent with an economy that is adding new people and increasing economic participation/ improving productivity amongst existing participants. Inflation is a desirable by-product of organic growth in a debt-driven financial system. Of course inflation must not be allowed to get out of control because hyperinflation is even worse than deflation, e.g. Venezuela, Zimbabwe
In my college macroeconomics course the basic explanation was that there is a constant short run tradeoff between unemployment and inflation (called the [Phillips Curve](https://www.investopedia.com/terms/p/phillipscurve.asp)) and that at most times the proper balance between the two involved some inflation to increase employment.
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