Nobody enjoys having to pay more for something. That’s why inflation, particularly the recent steep price hikes, feels like a filthy word.
Inflation, on the whole, can be beneficial to many working-class Americans, particularly those with fixed-rate debt such as a 30-year mortgage. Because salaries are rising, workers are becoming more empowered while simultaneously having more money to pay off debt. Plus, with a mortgage, your monthly payment will remain the same while the value of your home increases.
When prices rise, many of the people who take a bath are high-net-worth individuals who own the great majority of government bonds.
“There is a light at the end of the tunnel, but it could be a couple of years,” said Kent Smetters, a Wharton School of Business professor of business economics.
How inflation favors debtors
The immediate benefits of inflation to ordinary people are less tangible than the disadvantages you may feel the pinch of a higher food price and the gut-punch of a higher petrol bill. The shrinking load of your debt is less visible but still considerable.
Why is inflation actually beneficial?
- Inflation, according to economists, occurs when the supply of money exceeds the demand for it.
- When inflation helps to raise consumer demand and consumption, which drives economic growth, it is considered as a positive.
- Some people believe inflation is necessary to prevent deflation, while others say it is a drag on the economy.
- Some inflation, according to John Maynard Keynes, helps to avoid the Paradox of Thrift, or postponed consumption.
Is inflation ever a positive thing?
Inflation is beneficial when it counteracts the negative impacts of deflation, which are often more damaging to an economy. Consumers spend today because they expect prices to rise in the future, encouraging economic growth. Managing future inflation expectations is an important part of maintaining a stable inflation rate.
Fixed-rate mortgage holders
According to Mark Thoma, a retired professor of economics at the University of Oregon, anyone with substantial, fixed-rate loans like mortgages benefits from increased inflation. Those interest rates are fixed for the duration of the loan, so they won’t fluctuate with inflation. Given that homes are regarded an appreciating asset over time, homeownership may also be a natural inflation hedge.
“They’re going to be paying back with depreciated money,” Thoma says of those who have fixed-rate mortgages.
Property owners will also be protected from increased rent expenses during periods of high inflation.
Advantages of Inflation
- Deflation has the potential to be exceedingly harmful to the economy, as it might result in fewer consumer spending and growth. When prices are falling, for example, buyers are urged to put off purchasing in the hopes of a lower price in the future.
- The real worth of debt is reduced when inflation is moderate. In a deflationary environment, the real value of debt rises, putting a strain on discretionary incomes.
- Inflation rates that are moderate allow prices to adjust and goods to reach their true value.
- Wage inflation at a moderate rate allows relative salaries to adjust. Wages are stuck in a downward spiral. Firms can effectively freeze pay raises for less productive workers with moderate inflation, effectively giving them a real pay cut.
- Inflation rates that are moderate are indicative of a thriving economy. Inflation is frequently associated with economic growth.
Disadvantages of Inflation
- Inflationary rates create uncertainty and confusion, which leads to less investment. It is said that countries with continuously high inflation have poorer investment and economic growth rates.
- Increased inflation reduces international competitiveness, resulting in less exports and a worsening current account balance of payments. This is considerably more troublesome with a fixed exchange rate, such as the Euro, because countries do not have the option of devaluation.
- Inflation can lower the real worth of investments, which can be especially detrimental to elderly persons who rely on their assets. It is, however, dependent on whether interest rates are higher than inflation.
- The real value of government bonds will be reduced by inflation. To compensate, investors will demand higher bond rates, raising the cost of debt interest payments.
- Hyperinflation has the potential to ruin an economy. If inflation becomes out of control, it can lead to a vicious cycle in which rising inflation leads to higher inflation expectations, which leads to further higher prices. Hyperinflation can wipe out middle-class savings and transfer wealth and income to people with debt, assets, and real estate.
- Reduced inflation costs. Governments/Central Banks must implement a deflationary fiscal/monetary policy to restore price stability. This, however, results in weaker aggregate demand and, in many cases, a recession. Reduced inflation comes at a cost: unemployment, at least in the short term.
When weighing the benefits and drawbacks of inflation, it’s vital to assess the sort of inflation at hand.
- It’s possible that cost-push inflation is simply a blip on the radar (e.g. due to raising taxes). As a result, this is a one-time issue that isn’t as significant as deep-seated inflation (e.g. due to wage inflation and high inflation expectations)
- Cost-push inflation, on the other hand, tends to lower living standards (short-run aggregate supply is shifted left). Cost-push inflation is also difficult to manage because a central bank cannot simultaneously cut inflation and boost economic growth.
- It also depends on whether or not inflation is expected. Many people, particularly savers, are more likely to lose out if inflation is significantly greater than expected.
Is stock market inflation beneficial?
Consumers, stocks, and the economy may all suffer as a result of rising inflation. When inflation is high, value stocks perform better, and when inflation is low, growth stocks perform better. When inflation is high, stocks become more volatile.
What level of inflation is considered healthy?
The Federal Reserve has not set a formal inflation target, but policymakers usually consider that a rate of roughly 2% or somewhat less is acceptable.
Participants in the Federal Open Market Committee (FOMC), which includes members of the Board of Governors and presidents of Federal Reserve Banks, make projections for how prices of goods and services purchased by individuals (known as personal consumption expenditures, or PCE) will change over time four times a year. The FOMC’s longer-run inflation projection is the rate of inflation that it considers is most consistent with long-term price stability. The FOMC can then use monetary policy to help keep inflation at a reasonable level, one that is neither too high nor too low. If inflation is too low, the economy may be at risk of deflation, which indicates that prices and possibly wages are declining on averagea phenomena linked with extremely weak economic conditions. If the economy declines, having at least a minor degree of inflation makes it less likely that the economy will suffer from severe deflation.
The longer-run PCE inflation predictions of FOMC panelists ranged from 1.5 percent to 2.0 percent as of June 22, 2011.
What makes inflation so bad?
If inflation continues to rise over an extended period of time, economists refer to this as hyperinflation. Expectations that prices will continue to rise fuel inflation, which lowers the real worth of each dollar in your wallet.
Spiraling prices can lead to a currency’s value collapsing in the most extreme instances imagine Zimbabwe in the late 2000s. People will want to spend any money they have as soon as possible, fearing that prices may rise, even if only temporarily.
Although the United States is far from this situation, central banks such as the Federal Reserve want to prevent it at all costs, so they normally intervene to attempt to curb inflation before it spirals out of control.
The issue is that the primary means of doing so is by rising interest rates, which slows the economy. If the Fed is compelled to raise interest rates too quickly, it might trigger a recession and increase unemployment, as happened in the United States in the early 1980s, when inflation was at its peak. Then-Fed head Paul Volcker was successful in bringing inflation down from a high of over 14% in 1980, but at the expense of double-digit unemployment rates.
Americans aren’t experiencing inflation anywhere near that level yet, but Jerome Powell, the Fed’s current chairman, is almost likely thinking about how to keep the country from getting there.
The Conversation has given permission to reprint this article under a Creative Commons license. Read the full article here.
Photo credit for the banner image:
Prices for used cars and trucks are up 31% year over year. David Zalubowski/AP Photo
What would happen if inflation didn’t exist?
If there is no increase in inflation (or if inflation is zero), the economy may go into deflation. Reduced pricing equals less production and lower pay, which pushes prices to fall even more, resulting in even lower wages, and so on.
Is inflation beneficial or detrimental to debt?
Inflation, by definition, causes the value of a currency to depreciate over time. In other words, cash today is more valuable than cash afterwards. As a result of inflation, debtors can repay lenders with money that is worth less than it was when they borrowed it.
What effect does inflation have on the economy?
- Inflation, or the gradual increase in the price of goods and services over time, has a variety of positive and negative consequences.
- Inflation reduces purchasing power, or the amount of something that can be bought with money.
- Because inflation reduces the purchasing power of currency, customers are encouraged to spend and store up on products that depreciate more slowly.