Why is inflation good for an economy?
In: Economics
In an ideal world there would be no inflation and prices would remain constant at all times. Unfortunately, due to supply and demand, inflation is inevitable and will fluctuate as items levels of supply and demand change. There are other reasons why inflation occurs but supply and demand is the main one. So, governments often target a low level of inflation so that it does not get out of hand. This keeps prices generally stable and allows people, governments and corporations to plan ahead.
So, inflation is not good but a low and stable level of inflation is better than an inflation rate that wildly fluctuates.
It compels people to do something with their money — either spend it (before prices go up), or invest it (making the capital available to borrow, fueling economic growth). Either way, it keeps money flowing in the economy. If there was no inflation, people could just stash their money in unproductive ways, ie. stick it under their mattress, where it doesn’t serve any benefit to the current economy.
And a small bit of inflation is preferable to no inflation in that it could also backslide into deflation, where people then sit on money waiting for prices to fall rather than spend and bring the economy to a screeching halt.
It’s more that deflation is very bad for an economy.
If my money buys me a better car in a year why buy a new car now? This logic applies as long as the value of my money increases and that will lead me to stop spending money which is very bad for the economy.
Inflation has the opposite effect. The same amount of money will buy me a worse car, or TV or what ever next year so I better buy it now. Keeps the money circulating which is good for the economy.
I’m not sure that there is a consensus that it is, but in general, a low level of inflation becomes an incentive to spend and/or invest money, rather than simply sitting on it, since cash loses purchasing power over time when inflation is present. What most central banks want to avoid is *deflation*, since that increases the purchasing power of cash over time. And when people expect prices to be lower six months from now than they are today, they tend to put off purchases, and that increase to the savings rate can trigger a recession by itself. Note while it’s hard to see a reason why a high savings rate is bad for an individual or a family, when large numbers of people start saving their money, rather than spending, it can slow economic activity enough that it’s noticeable. (It’s called “The Paradox of Thrift.)
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