Readers Question: what are the advantages and disadvantages of inflation?
The Advantages of Inflation:
1. Deflation (a fall in prices – negative inflation) is very harmful. For example, the Japanese economy has suffered lower growth because of deflation. When prices are falling people are reluctant to spend money because they are concerned that prices will be cheaper in the future, therefore, they keep delaying purchases. There are many more cost of deflation in this essay on: Costs of deflation
2. Moderate inflation enables adjustment of prices and wages. It is argued a moderate rate of inflation makes it easier to adjust relative wages and prices. For example, it may be difficult to cut nominal wages (workers resent wage cut). But, if average prices are rising, it is easier to increase good workers wages more than unproductive workers.
3. Inflation can boost growth. At times of very low inflation the economy may be stuck in a recession. Arguably targeting a higher rate of inflation can enable a boost to growth. This view is controversial. Not all economists would support targeting a higher inflation rate. However, some would target higher inflation, if the economy was stuck in a prolonged recession. See: Optimal inflation rate
Disadvantages of Inflation
Inflation is considered to be a problem when the inflation rate rises above 2%. The higher the inflation, the more serious the problem it is.
- In a modern economy, the Government are most concerned about the destabilising impact of inflation.
- Inflationary growth tends to be unsustainable leading to a damaging period of boom and bust economic cycles.
- Inflation tends to discourage investment and long term economic growth. This is because of the uncertainty and confusion that is more likely to occur during periods of high inflation.
- Inflation can make an economy uncompetitive. For example, higher rate of inflation in Italy can make Italian exports uncompetitive. This is particularly important for countries in the Euro-zone because they can’t devalue to restore competitiveness.
- Reduce value of savings. Inflation leads to a fall in the value of money. This makes savers worse off and can lead to a redistribution of income in society. Often it is pensioners who lose out most from inflation. This is particularly a problem if inflation is high and interest rates low.
- Menu costs – costs of changing prices lists. Not so significant with modern technology.