What are the costs of inflation? Which is most important? How about deflation? Would that be a problem and for whom? The FRB worries more about deflation. Why? Do you agree? Why or why not?
Effects of Inflation:
- Erodes Purchasing Power
- Encourages Spending, Investing
- Causes More Inflation
- Raises the cost of borrowing
- Lowers the cost of borrowing (when no central bank)
- Reduces Unemployment
- Increases Growth
- Reduces Employment, Growth
- Weakens or Strengthens Currency
I believe the most important effect of inflation is #3 that it can cause more inflation. This can create a viscous cycle called hyperinflation. The urge to spend and invest in the face of inflation tends to boost inflation and then creates more inflation. No one wants to hold cash when inflation keeps rising so they push up pricing by showing such high demand for goods and services. The supply of money outstrips the demand and the price of money falls at a faster rate. This can cause hoarding and empty grocery store shelves. A scary sight indeed.
Deflation is the fall of the overall level of prices and thus an increase in purchasing power of the currency. This can be driven by an increase in productivity, the abundance of goods and services, or by a decrease in the supply of money and credit. Sounds kinda nice, doesn’t it? This can be a positive trend for an economy. A fall in prices allows consumers to consume more but can promote economic growth and stability by enhancing the function of money as a store of value and encourage saving.
Deflation can also be bad as some may have trouble refinancing debt, or making payments on debt obligations such as business loans, mortgages, car or student loans, etc. Falling prices will put more pressure on indebted businesses, consumers, and investors because the nominal value of their debts will remain fixed as the corresponding nominal value of their revenues falls. This could cause business failures, bankruptcies, and increasing unemployment.
A little bit of deflation is a good thing in the short term, but could cause problems as most of our economy is built on an assumption of a little bit of inflation each year.
I think the Federal Reserve worrying about both inflation and deflation is a good thing. We are lucky to have such a smart system setup to help our economy stay protected. And most importantly we have good data that comes in quickly so that our leaders can make quick decisions when needed. I think the fed really likes a small amount of inflation as it relates to GDP growth and the access to our money supply. Deflation seems to spiral out of control quicker than inflation, and seems harder to stop. So to worry about deflation is a good thing.
As long as our incomes continue to rise in pace with the CPI inflation rate, should we care about inflation at all? What if our wages don’t keep up with CPI? That would mean we are getting poorer. You should understand CPI to have the discussion with your boss about your raise you want to get. It makes economic sense to always at least get 2-3% inflation raises per year. And if you work hard enough, you ask for more than 3%.
Dude.World 