Who is inflation good for

Policy makers believe that a slow gradual increase in overall price level keeps businesses profitable and even prevent deflation.

Healthy inflation is brought about by healthy economic growth. Usually it is a result of GDP expansion, wage growth, increase in investment activities and consumer spending. It also contributes to full employment levels. The concern is whether the inflation we are facing today will potentially run off leading to stagflation or even hyperinflation. This was attributed to President Nixon who ended the gold standard in The USD plummeted on the foreign exchange markets.

Subsequent Fed Chairman tried to control the inflation but did a bad job simply because consumers and companies started buying ahead of time, for fear the price will keep increasing. Then Paul Volcker came into the picture. A steadfast Fed Chairman who was independent minded, he raised interest rate significantly by 8. He did so regardless of opposition to overcome the wild inflation in the growing economy. It succeeded to bring inflation down to a moderate level but the side effect was an month-long recession.

Many industries like real estate and auto industry were affected, being a casualty of high interest rates. However, by the time he left office, the economy recovered and ushered 20 years of strong economy for the US.

This inadvertently helped President Ronald Reagan win the election and built a strong presidential legacy throughout his tenure.

It usually only happens during times of war, turmoil and great disaster. Indeed, I agree the current inflation is unhealthy. Going back to basics, what we are experiencing is not demand driven. In my observation, this is primarily caused by extremely accommodative monetary policy resulting in excess liquidity in the economy, supply shortage due to prolonged Covid shutdown, slow restart of factory, supply chain issues and uneven recovery in economies globally. She believes it is temporary and will recede to normal levels in the not-too-distant future.

Current Fed Chairman, Jerome Powell on 29th September , maintained his view that inflationary pressure will ease once supply chain bottleneck eases and demand returns to pre-pandemic levels. Hence, the argument between policymakers are about supply crunch versus demand surge and whether it is transitionary or here to stay.

To be honest, it is never easy to get it right. Given the chance, policymakers should be firm to take the foot off the gas and allow the economy to function on its own. Accommodative monetary policies and overly aggressive fiscal spending using the pandemic as sole justification is not sound policy making. It is merely taking the easy way out by running more deficits to spur artificial growth. Inflation requires prices to rise across a "basket" of goods and services, such as the one that comprises the most common measure of price changes, the consumer price index CPI.

When the prices of goods that are non-discretionary and impossible to substitute—food and fuel—rise, they can affect inflation all by themselves. For this reason, economists often strip out food and fuel to look at "core" inflation , a less volatile measure of price changes.

A predictable response to declining purchasing power is to buy now, rather than later. Cash will only lose value, so it is better to get your shopping out of the way and stock up on things that probably won't lose value. For consumers, that means filling up gas tanks, stuffing the freezer, buying shoes in the next size up for the kids, and so on. For businesses, it means making capital investments that, under different circumstances, might be put off until later.

Many investors buy gold and other precious metals when inflation takes hold, but these assets' volatility can cancel out the benefits of their insulation from price rises, especially in the short term.

Over the long term, equities have been among the best hedges against inflation. At close on Dec. Of course not every stock would have performed as well as Apple: you would have been better off burying your cash in than buying and holding a share of Houston Natural Gas, which would merge to become Enron. Unfortunately, the urge to spend and invest in the face of inflation tends to boost inflation in turn, creating a potentially catastrophic feedback loop.

As people and businesses spend more quickly in an effort to reduce the time they hold their depreciating currency, the economy finds itself awash in cash no one particularly wants. In other words, the supply of money outstrips the demand, and the price of money—the purchasing power of currency—falls at an ever-faster rate. When things get really bad, a sensible tendency to keep business and household supplies stocked rather than sitting on cash devolves into hoarding, leading to empty grocery store shelves.

People become desperate to offload currency so that every payday turns into a frenzy of spending on just about anything so long as it's not ever-more-worthless money. Note: By December , an index of the cost of living in Germany increased to a level of more than 1. As these examples of hyperinflation show, states have a powerful incentive to keep price rises in check. For the past century in the U.

To do so, the Federal Reserve the U. If interest rates are low, companies and individuals can borrow cheaply to start a business, earn a degree, hire new workers, or buy a shiny new boat. In other words, low rates encourage spending and investing, which generally stokes inflation in turn. By raising interest rates, central banks can put a damper on these rampaging animal spirits. Suddenly the monthly payments on that boat, or that corporate bond issue, seem a bit high.

Better to put some money in the bank, where it can earn interest. When there is not so much cash sloshing around, money becomes more scarce. That scarcity increases its value, although as a rule, central banks don't want money literally to become more valuable: they fear outright deflation nearly as much as they do hyperinflation.

Another way of looking at central banks' role in controlling inflation is through the money supply. If the amount of money is growing faster than the economy, the money will be worthless and inflation will ensue. That's what happened when Weimar Germany fired up the printing presses to pay its World War I reparations, and when Aztec and Inca bullion flooded Habsburg Spain in the 16th century. When central banks want to raise rates, they generally cannot do so by simple fiat; rather they sell government securities and remove the proceeds from the money supply.

As the money supply decreases, so does the rate of inflation. When there is no central bank, or when central bankers are beholden to elected politicians, inflation will generally lower borrowing costs. When levels of household debt are high, politicians find it electorally profitable to print money, stoking inflation and whisking away voters' obligations. If the government itself is heavily indebted, politicians have an even more obvious incentive to print money and use it to pay down debt.

If inflation is the result, so be it once again, Weimar Germany is the most infamous example of this phenomenon. Politicians' occasionally detrimental fondness for inflation has convinced several countries that fiscal and monetary policymaking should be carried out by independent central banks.

While the Fed has a statutory mandate to seek maximum employment and steady prices, it does not need a congressional or presidential go-ahead to make its rate-setting decisions. That does not mean the Fed has always had a totally free hand in policy-making, however.

Former Minneapolis Fed President Narayana Kocherlakota wrote in that the Fed's independence is "a post development that rests largely on the restraint of the president.

There is some evidence that inflation can push down unemployment. Wages tend to be sticky , meaning that they change slowly in response to economic shifts. John Maynard Keynes theorized that the Great Depression resulted in part from wages' downward stickiness. Unemployment surged because workers resisted pay cuts and were fired instead the ultimate pay cut. The same phenomenon may also work in reverse: wages' upward stickiness means that once inflation hits a certain rate, employers' real payroll costs fall, and they're able to hire more workers.

That hypothesis appears to explain the inverse correlation between unemployment and inflation —a relationship known as the Phillips curve —but a more common explanation puts the onus on unemployment. As unemployment falls, the theory goes, employers are forced to pay more for workers with the skills they need.

As wages rise, so does consumers' spending power, leading the economy to heat up and spur inflation; this model is known as cost-push inflation. Unless there is an attentive central bank on hand to push up interest rates, inflation discourages saving, since the purchasing power of deposits erodes over time. That prospect gives consumers and businesses an incentive to spend or invest.

At least in the short term, the boost to spending and investment leads to economic growth. By the same token, inflation's negative correlation with unemployment implies a tendency to put more people to work, spurring growth. This effect is most conspicuous in its absence. In , central banks across the developed world found themselves vexingly unable to coax inflation or growth up to healthy levels. Cutting interest rates to zero and below did not seem to be working.

Neither did the buying of trillions of dollars worth of bonds in a money-creation exercise known as quantitative easing. This conundrum recalled Keynes's liquidity trap , in which central banks' ability to spur growth by increasing the money supply liquidity is rendered ineffective by cash hoarding, itself the result of economic actors' risk aversion in the wake of a financial crisis.

Liquidity traps cause disinflation, if not deflation. In this environment, moderate inflation was seen as a desirable growth driver, and markets welcomed the increase in inflation expectations due to Donald Trump's election.

In February , however, markets sold off steeply due to worries that inflation would lead to a rapid increase in interest rates. At that level, inflation robs you of your hard-earned dollars.

The prices of things you buy every day rise faster than wages. Galloping inflation occurred during the s. It prompted President Ronald Reagan to famously say, "Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman. The worst types of inflation are hyperinflation and stagflation.

It can more quickly put the brakes on rising prices by raising interest rates. The housing industry provides an example of both inflation and deflation. Until , gradually rising prices attracted investors. They saw there was a chance to make money by buying now and selling later. This created more jobs as home builders tried to meet demand. But between and , the housing market experienced massive deflation.

Those who could afford to buy a house decided to wait until the market improved. The longer they waited, the lower prices dropped.

Many people were trapped in their homes. They could not sell their homes for enough to cover the mortgages. They became upside-down. Eventually, they could not see any light at the end of the tunnel. Even those who could afford to keep paying, often just walked away.

This sent prices even lower. Others were counting on being able to sell their home in a year or so. They were relying on this to cover a mortgage they could not afford. They foreclosed and lost their home when they were unable to cover their loan.

This happened to so many people that there was a glut on the market. Homes that are left behind are called "shadow inventory," they were was not really absorbed until Those who kept paying their loans had less money to spend on other things. This drove down demand in other sections of the economy. What did they get in return? An ever-deflating asset. Board of Governors of the Federal Reserve System. Frederic B.

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