Why a little Inflation is Good?

Discover why a small amount of inflation is essential for a healthy economy and the dangers of deflation. Learn how the deflationary spiral can stifle economic growth and why managing inflation is crucial.

We all know that Inflation is so bad for a nation and what it can do to the economy. But do you know that a little inflation is always a good thing?

Yes, you read that right. In fact, each country has their inflation targets and it is very key to maintain the threshold to have a healthy economy. (You can find each country's inflation target here)

Why?

Because when inflation goes below 0% (aka Deflation) it’s really hard to fix. The cost of deflation is really high.

But how come?

For that, you need to understand the Deflationary Spiral.

😵‍💫 The Deflationary Spiral

The deflationary spiral cycle is very similar to the inflationary cycle except that it functions in the reverse direction.

When prices fall, consumers hold off spending on making big purchases, hoping for even more lower prices in the future and stuff that we require in day-to-day life costs less, so we basically spend less in general. If people are spending less, companies make less. If companies make less, they cut costs on innovation, R&D, and new projects, hire fewer people, lay off, and cut wages and salaries. So, people will eventually spend less and start saving cause of the volatility. And this gets into the deflationary spiral. All of this adds up to slower economic growth.

And why is Deflation more dangerous than Inflation?

Cause when the inflation rises, the government at least know a way to cool it down - they can pull the lever of interest rates - Hike the interest rates and force people to spend less.

But when there is deflation, the government doesn’t know how to make people spend more. That’s why they say the cost of deflation is high.

One could argue that, if the government is increasing the interest rates to cool down the inflation, they could as well lower the interest rates to increase the spending, right?

That's called Quantitative Easing → it is a method whereby the US Fed reserve lowers interest rates and prints more dollars to get the market working which increases the purchasing power of individuals leading to increased demand which in turn leads to an increase in the cost of goods in the market. This increases spending but also brings inflation, and there is no guarantee that inflation will come back to the normal stage.

An ideal example would be the 2020 COVID scenario when interest rates were lowered nearly to 0% to avoid deflation and to retrieve the economy the Government pumped tons of money into the economy, and we are still facing the repercussions of that decision. Yes, it worked to an extent. The inflation got back to its normal stage but it didn't stop there and it went on increasing touching an all-time high. That’s why they say it is costly to fix deflation.

Japan is finally out of chronic deflation, and they have finally realised that their economy is not booming when Inflation is below 0%. Check out this video to learn more.

So what do you think about Deflation and are you now convinced that a little inflation is good for the economy? Comment down your thoughts.