Readers Question: Why does the cost of living keep rising?
This is due to inflation – the persistent increase in the average price level. In modern economies, inflation is a common feature. In fact most Central Banks target a low rate of inflation of 2%.
Central banks feel that a moderate rate of inflation is consistent with a steady rate of economic growth.
For various reasons a zero inflation rate could create problems – especially, if people are used to moderate inflation. See: costs of low inflation and deflation.
The important thing is – are incomes rising faster than prices and the cost of living? If your cost of living rises at 2%, but average incomes are rising at 5% a year, then you’re real income is increasing by 3% – you are better off, despite the increased cost of living.
However, if prices are rising, and your income staying the same, then your real income is falling – you are effectively worse off because you cannot afford to buy as many goods.
Prices don’t always rise
Note. prices don’t always rise. In the 1920s and 1930s, the UK had a period of deflation – falling prices and the cost of living was going down. However, this wasn’t a good situation because it was also a period of high unemployment and low growth. Japan has experienced deflation in recent decades, and the EU is getting close to zero inflation
Why is inflation considered normal in modern economies?
I’m not exactly sure, but somehow economic growth tends to cause some moderate price rises. Also, a low inflation of 2%, makes it easier for relative prices to adjust. With inflation of 2% – some prices like services may rise by 4%, some prices like mobile phones may stay at 0%. Some goods like food may rise by 2%.
Because there is downward price and wage rigidity, it is easier to have these price adjustments with low inflation than zero inflation.