A little inflation is good for economy?

What is inflation?

Inflation is defined as sustained increase in the general level of prices for goods and services and measured as an annual percentage increase.

In other words, inflation reduces the purchasing power of your money. For example if the inflation rate is 2% annually, the Re.1 toffee will cost you Rs.1.02 next year.

Is inflation bad?

Inflation can be good or bad in certain conditions. Inflation often works as ‘Inflationary spiral’. This happens when prices rise, so firms have more profits, so they hire more workers, this sends wages up, so people have more money to spend on higher priced goods, so demand increases, and the prices keep going up.

So how bad an upward inflationary spiral can be? Currently the rate of inflation in Zimbabwe is 231 million percent, just because of upward inflationary spiral. It’s called as Hyper-inflation.

A downward inflationary spiral is worse than an upward one. People get laid off, spend less, prices get cheaper, which leads to people waiting to make purchases as they think that prices will continue to fall, so firms cut costs and lay off workers to reduce prices further, but consumers have less money to spend so they still don’t buy, so more people get laid off, and so on. The negative inflation is called as Deflation.

A deflation may seem like a good thing in the eye of an average consumer, it can lead to collapse of any economy to the ground. As most economists say a hyper-inflation is always better than deflation, because deflation is almost impossible to control unlike hyper-inflation.

Why little inflation is better?

A little inflation (around 3-5%) is always considered as good for overall growth of economy. Some of the reasons for the same are as following:

  • The consumer always expects the prices of goods to increase, so they spend more frequently, which increases demand and provide profitability to the manufacturers.
  • A little inflation is a sign of growing and healthy economy.
  • Inflation always works as a lubricant for any shock to economy and help it to recover. For example in a recession time cutting wages are considered more profitable than cutting jobs, but the earlier is not accepted easier than the later, and as we know job cuts are always bad for economy. But if there’s inflation in economy, employers just need to provide lesser raise than inflation rate and no one would mind.
  • Inflation drives people to invest their money, instead of locking them up, because each day reduces the purchasing power of money and it’s better to invest than loose purchasing power.
  • Investment helps companies or government to raise money for growth easier.

So now the question is ‘when a little inflation is good for economy?’ and the answer is ‘always’.