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Perhaps I am economically naive, but why does there need to be any inflation? Why isn't 0 a target?

• aidenn0 11y ago
  Inflation acts as a tax on dollar-denominated savings. A modest inflation rate encourages people to do something with their dollars other than put them under the mattress.
• superuser2 11y ago
  People with money just sitting on cash (instead of investing) is a nightmare scenario - it's the shape of global economic meltdown. Capitalism requires that people with capital invest it. In theory, capital gets something worth more than what they spent, a business is created, it pays employees who pay other businesses who pay employees, etc. and you get a self-sustaining cycle of prosperity. Everybody is better off than they were before. Inflation encourages investment - you need to invest in securities with a rate of return at least as good as inflation in order to not lose money. Incentives are aligned to make you do the thing that keeps the cycle going. Deflation encourages hoarding - you would do better to keep the money under your mattress and wait for prices to fall before circulating it. Incentives are aligned to make you do the thing that destroys the economy. Inflation in principle isn't horrible, but inflating prices while wages stagnate leaves everyone objectively worse off than they were before. This is already happening to an extent and causes a baseline level of unhappiness; if it were to get out of control things would be very ugly. The task of a central bank is to use some very broad levers (interest rates, creating currency, etc) to try to keep the rate of inflation low but positive.
  • bko 11y ago
    If deflation encourages hoarding, why don't we see that in items that are well understood to be deflationary? An example is technology. Everyone knows that the value of their smartphone will decrease by ~25-50% a year, but we still purchase them. Economists discount deflation as being dangerous with just one sentence (it encourages hoarding). Are there any examples of deflation actually being harmful in an economy? There are plenty of examples of inflation being dangerous [0]. Technology is an example where deflation does not encourage hoarding. [0] https://en.wikipedia.org/wiki/Hyperinflation https://en.wikipedia.org/wiki/Hyperinflation
    • Retra 11y ago
      Money works differently from technology. You can trade old cash for an amount of new cash with the same face value whenever you want. If I bought a computer for $600 in 1980, it's not going to be traded for $600 today. But if I got a $600 check in 1980, I could cash it today for $600. Inflation is what makes this a reasonable thing to do. If money deflated, I wouldn't cash my check, I'd want to hold it for as long as possible. Deflation basically means you collect interest on any cash you have.
      • bko 11y ago
        Yes you may not cash it in today if it's going to be worth more tomorrow but you also wouldn't have the money to use for something else you value. I don't see how that's different from choosing not to spend $600 for a computer today knowing that it'll be only cost $500 a year from now. You buy it today because it has a higher value to you now rather than a year from now (we still prefer things sooner as opposed to later, despite deflation). You would also may choose to cash in the $600 knowing well that it will be worth more if you wait because you want to spend it on something now. Even with deflation, people would still spend money as we prefer to consume now rather than later. If cash had a positive return, I'd imagine riskier assets would have an even greater return so you wouldn't necessarily be all tied in cash. I know cash has a negative return (due to inflation) but I still hold it.
        • superuser2 11y ago
          I wrote a longer reply, but the problem is you're looking at this from the side of consumers consuming things they want. I don't give a shit about the resale value of my Macbook Pro, and in 2015 if you're buying a new car you're well aware that you're throwing away the first third of its value in 5 years. Deflation is not a concern when we're talking about people buying things for the joy of owning them. What we're talking about is investors buying things (like capital equipment) for the purpose of making money. But even for an individual - would you go $200k into debt for a house that's going to be worth $50k in 10 years? Of course not! A rational actor would even shy away from leases - you want to jump to something cheaper (or better for the same price) as frequently as possible, to minimize the amount of time that you're paying above market value for housing. Just like how you want to move between tech jobs relatively frequently to minimize the amount of time you're being paid below market value.
• roymurdock 11y ago
  While there is agreement that inflation is costly and should therefore be minimized, for a number of reasons policymakers nevertheless aim for an inflation rate above zero. First, available measures of inflation are imperfect and tend to overstate “true” inflation. Second, a little inflation may make it easier for firms to reduce real wages—without cutting nominal wages—when necessary to maintain employment in an economic downturn. Third, a negative inflation rate—deflation— could be even more costly than a similar rate of inflation, suggesting that a low rate of inflation might be desirable to insure against falling prices. Finally, at very low levels of inflation, nominal short-term interest rates may be very close to zero, limiting a central bank’s ability to ease policy in response to economic weakness. Because nominal rates cannot fall below zero, policymakers cannot cut short-term interest rates any further once they have lowered these rates to zero. - George Kahn, VP Federal Reserve Bank of Kansas Basically, it's because people want to see their wages go up, and a central bank loses the power to set short term interest rates when inflation is 0%, as we've witnessed in the US over the past 6 years.
• wcummings 11y ago
  To encourage spending
  • hugh4 11y ago
    Inflation of zero is just as good for encouraging spending as small positive inflation -- the rate you'll get by low-risk investing will always beat inflation by a bit. But the moment inflation dips below zero it really starts discouraging spending. So I suspect it's about having a margin for error. Target zero and it will spend a lot of time negative, target mildly positive and it will spend most of its time mildly positive.
    • ancap 11y ago
      >But the moment inflation dips below zero it really starts discouraging spending. While this view is common, it is incorrect. This is obviously evident when you consider the price of computers and other tech products over the decades.
      • mizzao 11y ago
        The price of computers dropped because of returns to technology investment, not because of deflation.
        • ancap 11y ago
          Why the prices dropped is irrelevant. Clearly spending on tech products has not ceased.
      • AnimalMuppet 11y ago
        Even in computers, you had the dilemma of "should I buy now, or wait a year and get the same thing for less money?" That was a standard question for many years.
        • ancap 11y ago
          Despite that, companies like Apple have hundreds of billions in revenues. Which is to say, the falling prices aren't a real problem. After all, the same person could say they could get the same thing for even cheaper in 2 years, 3 years, 5 years or 10 years.
• pachydermic 11y ago
  http://www.federalreserve.gov/faqs/economy_14400.htm http://www.federalreserve.gov/faqs/economy_14400.htm
  • marcosdumay 11y ago
    Leave it to economists to claim a correlation, and simply forget to say that the best models (supported by lots of empirical evidence) predict it's a causation.
• nerfhammer 11y ago
  The consensus is that slight deflation is much more dangerous than slight inflation, so while zero would be ideal it's not worth the risk of deflation
• srmann 11y ago
  A popular modern economic theory is that if prices rise slowly over time, people will tend to purchase today instead of saving money to purchase tomorrow, since they believe the price of what they want will be higher tomorrow. If prices drop slowly over time, people will tend to save as long as possible before purchasing, since they believe the price of what they want will be lower tomorrow. Since simple economic productivity is measured by summing the amount of dollars spent, the theory is that for these reasons low inflation leads to productivity.
  • mindcrime 11y ago
    All of which would be perfectly reasonable if humans were completely rational actors. But we all know we're not. We're semi-rational at best. Yes we try to maximize utility, but we're not Commander Data, calculating equations in our heads down the the 999999 points of precision, and coldly make decisions based on purely financial measures. This is even more true for some things than others... few people are going to say "Hey, deflation is on, let me wait until next week to eat" when they're hungry today. I'm not saying deflation is good or anything, but an awful lot of economic theory is rooted in some pretty shaky foundations.
• VLM 11y ago
  Boost equity prices. Putting money in mattress gets -(inflation) return, so how about stocks? Very theoretically it sets a "you must be this tall to play" floor on stock financed capital projects. So if inflation is 4% and you think new railroad locomotives will pay off at 5% average, then you do it, or if new locos only pay off at 3% then you don't because you'd get a sub-inflation rate of return on stocks or bonds. Another argument is its essentially a long term debt jubilee, given the extremely optimistic assumption that wages rise with inflation (LOL, not so much since the 80s or so). So at both personal and corporate level, debts as a problem kind of go away with time. A decade of 70s style wage inflation would certainly help with the student loan crisis and the real estate price crisis.
• maratd 11y ago
  To make people feel good. Inflation means raises (even if productivity hasn't changed) and higher prices (shop keepers always love when prices go up, manufacturers increase revenue, etc.). Deflation means pay cuts (even if you didn't do anything wrong) and lower prices (shop keepers freak out when they keep the prices the same ... but fewer people buy. same with manufacturers). Things just work much better with inflation, rather than deflation.
• slv77 11y ago
  Banks are typically leveraged about 12 to 1 meaning that one dollar of the banks money is paired with 11 dollars of depositors money to fund a loan. Since the banks capital is scarce relative to depositors funds it is usually the limiting factor in how many loans can be made and the overall amount of money in the economy. When banks make a bad loan and are forced to write of the loan each dollar of loss results in 11 less dollars of loans that can be made. When this happens to a lot of banks at the same time you get a general decrease in the money supply and general deflation (like the Great Depression). A positive rate of inflation allows banks to resolve some bad loans simply by holding the loan until inflation increases the asset value above the loan amount rather than a write-off. Positive inflation, in other words, is a lubricant for the banking system to make it easier to resolve bad loans which makes issuing loans simpler. With zero percent inflation banks would demand higher standards for underwriting such as stronger credit and larger down payments. that would generally mean loans would be directed mostly towards older, larger and more established industries and less to newer and smaller industries. Less loans for young people and more for older people. As a side note what makes the Federal Reserve special is that it is allowed to make loans with infinite leverage on capital. That means instead of a 1 to 12 ration of a typical bank it could be 1 to 100 or 1 to 1000. To keep this special position any profits are foreited to the U.S. Government and implicitly any losses are also eaten by the U.S. Government as well. Which is why which assets the Feseral Reserve purchases is a sensitive topic.