If you were to read and watch a ton of inflation-related content, you’d also keep hearing this: a little inflation is a good thing.
Everybody wants a little inflation. But why? If rising prices hurt seemingly everyone, why can’t they just stay the same? Why can’t inflation be zero?
Why Do Governments Want Inflation?
The first reason inflation can’t stay at zero is because governments and their central banks don’t want it to. Lots of countries actively pursue what is called an inflation target.
In the US right now, it’s about 3%—the number used by most central banks across the world. But the truth is, that’s a pretty arbitrary number. The goal is what economists consider a virtuous cycle.
In times when prices are generally rising, people tend to expect them to rise further, which actually encourages people to spend money now on big durable purchases like cars or appliances in order to avoid having to pay more later.
And the stuff we need to buy no matter what—goods like food or clothing—gets more expensive too, which requires us to spend more either way.
Companies make more money, which means more people have jobs and more of their own money to spend. That means more demand and therefore higher prices.
So the cycle continues. But this bit of the cycle is crucial to its virtue: it’s okay if prices rise as long as wages rise too. You’ll still be able to afford the same goods if your wages keep pace with inflation—emphasis on the “if.”
In the US, for two years, wage growth lagged behind inflation. That trend reversed starting in mid-2023, with wages—especially at the bottom—keeping up with and even surpassing inflation.
That is a good thing. But we also have to remember that wages in this country are rock bottom and have been for way too long.
A disruption at any point in this loop can lead to the kind of high inflation we’ve experienced over the past few years—when supply chain interruptions created product shortages and some companies artificially drove up prices to increase their profits. Along with other factors, this effectively turned the virtuous cycle into a vicious one.
How Governments Control Inflation
The government does have tools to combat rising inflation. They usually shift things by raising interest rates, which makes all borrowing—including credit cards and bank loans—more expensive.
When borrowing costs go up, it becomes more expensive to make investments, hire people, and expand businesses, which eventually slows the economy down.
That’s what the US Federal Reserve did in 2022, which helped bring inflation closer to that 2% target while placing an even higher financial strain on families who may need to borrow just to make ends meet.
When the Fed uses interest rates to bring down inflation, what they’re really doing is tamping down demand. They’re essentially telling people, “You can’t have a job—let’s put you out of work so that demand slows and price growth slows.”
The Fed raises interest rates to slow down spending across the economy, partly by signaling to markets that they’re taking the problem seriously, which creates an expectation that inflation will fall.
The Risks of Deflation
But we also have to talk about what happens when prices fall instead of rise. That’s called deflation, and while falling prices might sound good, they can also introduce another kind of cycle—a deflationary spiral.
When prices fall, consumers may hold off on making big purchases, hoping for even lower prices in the future. And when the stuff we need costs less, we just spend less in general.
If people are spending less, companies make less, so they start to cut costs and ultimately lay off employees. Unemployed people spend less, and even those with jobs might choose to save more to guard against financial loss. As demand goes down, prices fall even further.
Ultimately, all of that adds up to slower economic growth, which is really hard to fix. Governments don’t have the same ability to respond to deflation as they do to inflation.
Looking at past trends, the last time inflation dipped below 2% in spring 2020, the US brought interest rates all the way down to 0.5%. That seemed to work, and inflation inched back up.
But if inflation hadn’t rebounded, the government would have had limited options—rates were already near zero, and then things could have gotten dicey.
Historically, periods of true deflation are rare, but when they do happen, fixing them requires a serious shock to the economy.
The Great Depression was, in part, a deflationary spiral that was only solved by the outbreak of World War II, when the government supercharged spending and employment.
Japan, after decades of chronic deflation, is finally emerging from it—thanks in no small part to the high inflation much of the world battled over the last few years. You don’t want to rely on those kinds of events to fix an economy.
This is where inflation targets come in. The macroeconomy is made up of the decisions of millions of people and businesses. The way those decisions interact is mind-blowing. Inflation will always fluctuate, even if just a little.
And this is the last big reason why central banks don’t want inflation at 0%. If inflation sits too low, that basic shakiness is constantly at risk of dropping into the deflation zone, triggering that bad cycle. The way to prevent that is to keep inflation just a little bit higher.
So, a little inflation is usually a good thing. Yeah, that’s annoying.