There are all sorts of economic bogeymen that we hear about in the media. Typically, these can change depending on the weather or the decade. However, there is consistently one phrase that we hear used in dangerous ways. That phrase, of course, is inflation. Inflation is what happens when the value of a currency decreases, usually due to a rise in the money supply. However, despite all of people’s fears about what inflation can do to the economy, is it really the danger that people assume it is? Here's a rundown on why and why not...
Inflation can be a mixed bag
The truth is, inflation can be exceptionally dangerous to the health of an economy. We have all learned and heard horror stories about how several countries after the Great Depression found themselves with piles of currency that was worth less than the paper it was printed on. Too much inflation can lead a country to financial ruin that is difficult pull out of. However, the important thing to note is that this is only the case with rampant inflation. A healthy economy actually needs a small level of inflation to increase the rate at which currency is spent on goods and services, thus growing the economy.
Rampant deflation is more dangerous
One of the big problems with assuming that inflation is inherently a problem is that it presumes that the opposite effect must be a good thing. The opposite in this case would be deflation, which is what happens when a currency increases in value, possibly through a decrease in the money supply (at least in relation to the population). However, deflation is just like inflation, and can be valuable or problematic, depending on context. One problem that happens when you have too much deflation, though, is that more money is spent on foreign goods, due to our currency’s strong value. This causes industry in the United States to drop off, which can cause real GDP to contract. There is a lot of nuance to deflation, which we've covered before, so please take a look through our blog to learn more.
A healthy level of inflation is important
In order for the economy to be stimulated into sustainable growth, some level of inflation is certainly necessary. People will place this number higher or lower, depending on who you ask. Currently, many economists, including those at the Federal Reserve, have put this number somewhere ranging between 2-3%, annually. If inflation drops beneath this point, in can slow down the velocity at which our currency travels, which causes real GDP to contract. So, inflation really is something that is incredibly necessary, although can be problematic if you suffer it, rampantly.