Why is inflation necessary

It therefore produces low growth and higher unemployment. If inflation in the UK exceeds that of other countries, it can also erode competitiveness. This can promote higher growth, by keeping interest rates lower for longer. But whatever the precise level, most do agree that a little dose of inflation is absolutely essential.

Image source, Thinkstock. How does inflation stimulate the economy? Why should borrowers love inflation? Image source, Getty Images. What effect does inflation have on wages? When there is a small level of inflation, consumers are encouraged to buy goods and services now because they think the prices will be higher in the future.

As demand increases, so does company revenues. This in turn leads to companies expanding their business by, for example, opening more stores and hiring new people. So growth is good for the economy but too much growth too fast will cause the RBA to think about raising rates. The central banks will look to slow the economy down if they see the inflation being too high as high inflation erodes the purchasing power for consumers.

So far there is an expectation of moderate rises in inflation, which means there are no signs yet of dramatic interest rate rises by central banks. Receive our weekly tips and strategies into your inbox each week. Would you like us to call you when we have a great idea? Why do we need inflation for a healthy economy? I get the idea behind being against inflation. Why would people want to see prices rise over time? In theory, this seems rational but theory rarely works in the real world.

In the real world, the economy operates based on expectations. And, right or wrong, inflation and deflation bring about a very different set of expectations about the future, which can subsequently impact the present. Deflation can create a brutal negative feedback loop. When prices fall people stop buying stuff today in the hopes that it will be cheaper in the future.

When people stop buying stuff today, demand for products and services wane, leading businesses to lay off workers. Deflation is one of the reasons the Great Depression was so awful. He had a good question for us:. The conventional wisdom seems to say that there has to be some inflation.

Anyone who lived through the s in the U. Under President Carter, inflation soared from 6. Labor economist Michael Strain at the American Enterprise Institute said that scary images of hyper-inflation in history — from Europeans carting around worthless money in the Great Depression, to gas lines and soaring U. Strain pointed out that the Federal Reserve has set an annual inflation target of 2. Why do economists and Federal Reserve governors think the U. One standard explanation is that if prices stop rising, consumers will hold back on spending, waiting to get a better deal.