Posted on January 1, 2019
The saying goes that a little inflation is good for the economy (whereas high inflation and deflation are bad). We are told this by the Federal Reserve, politicians and just about anywhere one can look online. The Fed embarked on multi-trillion dollar quantitative easing projects since the global financial crisis in 2008 in part just to stimulate inflation. So is a little inflation actually good?
Put simply, no. Any amount of inflation is not good for anyone other than the government (and yes the Federal Reserve is part of the government). To say a little of inflation is good is to also say a little additional taxation is good for the economy, which would obviously be a ridiculous statement. Inflation is just another form of taxation on users of the currency.
The government uses deflation as the main reason to justify inflation. However, the government is really concerned about distorting reality and keeping inflation as high as possible without causing concern by the public.
Deflation is an environment where prices for goods and services decrease over time. Deflation incentivizes businesses and consumers to delay consumption and investment since the prices paid in the future will be lower than today. A downward spiral could occur whereas lower prices would lead to less consumption. This is exactly what happened in the Great Recession where the Federal Reserve’s policies were deflationary in nature and caused the recession to be much longer than it needed to be.
But one does not have to create inflation to avoid deflation. Keeping the growth of the money supply tied to GDP growth would keep prices constant. Any discrepancies between the actual GDP growth rate and the forecasted rate (one would have to forecast the GDP growth to keep money expanding with growth) would be minimal and resolved by the market.
Further, if deflation was really a cause of concern the easiest way to tackle it would be to print more money. When I say print more money I’m not referring to quantitative easing whereas money is created and used to purchase bonds. Quantitative easing does not directly impact the public. What I am referring to is creating money and giving to the citizens for consumption – also referred to as helicopter money. Helicopter money is a horrible idea but it would most definitely create inflation if deflation where to ever occur.
The powers at be use deflation as a reason to create inflation but it’s just a facade. If price stability was really a goal then it could be accomplished relatively easily by linking money supply growth with real GDP growth.
Distortion is something the Federal Reserve is trying to create rather than reduce. A little inflation causes financial information to appear be a little bit better than it really is. The main idea is to distort reality with the intention of increasing business and consumer confidence, spurring further consumption and investment.
That might sound good at first. Isn’t more spending a good thing for the economy? Generally speaking yes. However, the decisions being made by the consumers and business executives are not based on accurate information but distorted information. We know that market economies need accurate information to function properly. Without accurate information consumers and businesses could be making bad financial decisions that will cause pain down the road. Remember the subprime mortgage fiasco that sparked the global financial crisis? That was based on inaccurate information of loan quality within securitized loans. Further, this distortion encourages spending which is to say it is also discouraging saving. Since savings are future expenditures it’s a tradeoff of consumption now various less consumption in the future.
The Bottom Line
Any amount of inflation is not good for the economy. Don’t be fooled into thinking there are any benefits of inflation besides parting you from your money. Additionally, inflation is a key part of keeping the economy rigged against your favor.