Home > Behavioural Economics, Inflation, Interest Rates > We need inflation to boost world economy

We need inflation to boost world economy

It seems ironic that after a global focus to contol inflaton it transpires that what we really need is more. According to Time magazine there are 2 key points why we need inflation:

1. Inflation would shrink the value of the debts both the government and borrowers have to pay, improving our collective balance sheets. Higher salaries would also make it easier for borrowers to pay back their loans helping banks.

2. This might be the more important reason now, inflation pushes people and companies to spend money. If you know prices are going to drop or stay flat, then you will delay a purchase. That’s why most of us are late adopters when it comes to technology. But if you know prices are going to rise, then you will spend your money now. So increasing inflation could stimulate the economy, as well as lower our debts.

Also, according to Paul Krugman, in the long run, it’s very difficult to cut nominal wages. However when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis. Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.

The fortunate aspect of all this is that creating inflation is not a difficult task. The central banks just have to keep rointing money and buying up government debt. The issue is to do with the long-run and that inflation could get out of control like that in the 1970’s – 20% instead of being below 10%. However it is all to do with inflationary expectations – behavioural economics.

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