Let’s break down why inflation can actually be beneficial.

Inflation is a complex issue that affects many aspects of the economy. In 2022, the world witnessed unusually high inflation rates. In the U.S., U.K., and Eurozone, these rates peaked at around 10%. This means that, on average, prices had increased by 10% compared to the prior year. Many people who observed the situation were not surprised. Thankfully, inflation has since moved closer to a normal range, though it still remains somewhat elevated. However, it’s important to clarify that the data showing a decrease in the rate of inflation does not indicate that prices are falling. Instead, it suggests that prices are rising at a slower pace. This is a disappointing reality for consumers.

People are feeling stressed due to these rising costs. Businesses are also facing challenges. Many are struggling to keep their doors open as they grapple with increased expenses. Meanwhile, governments worldwide are acting in response. They are trying to manage this inflation crisis. Amid these challenges, an interesting narrative has emerged: “A little inflation is a good thing."

This perspective raises an important question. If rising prices seem to hurt everyone, why is a bit of inflation viewed positively? Why can’t prices simply stabilize and remain unchanged? Why can’t inflation be zero?

The reality is that zero inflation is not desirable for many governments and their central banks. In fact, many countries actively pursue something called an "inflation target." For example, in the U.S., the target is around 2%. This target is similarly adopted by many central banks across the globe. However, it is worth noting that this target is somewhat arbitrary. Economists posit that moderate inflation can create a “virtuous cycle” in the economy.

So, what does this virtuous cycle look like? During periods when prices are generally rising, people tend to expect that trend to continue. Consequently, they are more likely to make purchases sooner rather than later. For instance, individuals might decide to buy large items such as cars or appliances now to avoid paying higher prices later. Additionally, essential goods like food or clothing also see increased prices, which forces consumers to spend more.

As a result, companies earn more revenue. This growth translates to more jobs, which allows individuals to earn and spend more. Thus, demand increases, and prices may continue to rise. This cycle feeds into itself, promoting more economic activity. However, the critical component of this cycle is the relationship between price increases and wage growth. It is generally acceptable for prices to rise, as long as wages are rising in tandem. As long as wages keep pace with inflation, consumers can continue to afford the same goods. Yet, this relationship is contingent.

In the U.S., for two years leading up to the middle of 2023, wage growth lagged behind inflation. This created a precarious situation for many Americans. Thankfully, a change has occurred. As of mid-2023, wages, particularly for lower-income workers, have started keeping up with inflation. In some cases, wage growth has even surpassed inflation. While this is a positive step, the reality remains that wages have been stagnating for too long.

Nonetheless, any disruption in this economic loop can lead to significantly high inflation, similar to what the world experienced in recent years. Issues such as supply chain interruptions and corporate price hikes to maximize profits have contributed to this problem. These factors have effectively transformed what should be a virtuous cycle into a vicious one.

Governments have specific tools to counter rising inflation. One common tactic is to increase interest rates. Higher interest rates make borrowing more expensive, including for credit cards and loans. This, in turn, impedes investments businesses might make to hire new employees. The overall effect tends to slow economic growth.

The U.S. Federal Reserve raised interest rates in 2022, which helped bring inflation closer to the 2% target. However, this move also placed additional financial burdens on families. Many people rely on borrowing to survive, and increased costs can be detrimental.

The Federal Reserve’s strategy aims to curb demand. They intend to communicate that they are seriously addressing the inflation issue. By slowing down spending in the economy, they seek to create an expectation that inflation will decline.

However, this approach comes with its risks. If prices were to fall instead of rise, that scenario would be labeled as “deflation.” While falling prices may seem appealing at first glance, they can initiate a negative cycle known as a “deflationary spiral.” When prices drop, consumers may hesitate to make significant purchases, believing prices will drop even more. As essential items become cheaper, overall spending decreases.

Lower consumer spending leads to reduced company revenues. Consequently, businesses may need to cut costs, often resulting in employee layoffs. Unemployed individuals spend less, further exacerbating the situation. This cycle can perpetuate falling prices, creating significant economic challenges.

Therefore, governments recognize that deflation can be just as dangerous as inflation,