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Is Inflation Really Good for the Economy?

by Chris Parry (Write for us)

Understanding how inflation affects our economy is key to grasping how our system truly works. However, the first step in this process, though, is learning more about the general nature of inflation‏.

Inflation occurs when the value of money‏

begins to fall, thereby decreasing purchasing power. There are a number of ways to measure inflation in the United States, and it is worth noting that inflation is greatly different from currency devaluation. The primary symptom of inflation is a rise in prices of consumer goods‏.

While many would suggest that the lower the rate of inflation, the better the market is for consumers, this simply isnt the case. In fact, you may have recently heard members of the federal government suggesting that they will use resources like the central bank to create and maintain certain levels of inflation as necessary for our economy. Former Fed Chair Greenspan even said that a fall in inflation rates would ruin our economy as a whole‏.

Excessive inflation, though, can be as problematic as the deflation process. The larger the system gets, the more imaginary profits are created. This creates a kind of bubble around a particular market. Thrifty spending is discouraged, debt is encouraged, and when the bubble finally comes crashing to Earth, billions are lost in investment dollars‏.

Inflation Policies in the United States‏

The Fed keeps a tight rein on both inflation and deflation, trying to create a happy medium that encourages moderate economic growth for the United States. As a result, there are several policies in place to deal with inflation (or deflation as the case may be). The Fed watches a number of things carefully to help determine the inflation policies for the country. One of their primary tools is the consumer price index. By examining the price of goods on a general level, the Fed can make decisions about whether or not to raise interest rates in an attempt to keep the market on a relatively stable level. By changing the level of the interest rate in the United States, the Fed can keep a tight rein on the level of inflation. Every six weeks, the Federal Reserve Board of the Open Market Operations Committee meets to set both the Fed funds rate and the discount rate, changing the inflation levels each time the rates go up or down. Policy makers as a whole tend to either tend to be more concerned with the growth of the GDP or more concerned with keeping the levels of inflation quite low within the country. It tends to be best to have a mixture of these two things at any given time in the Fed in order to set the best inflation policies for the United States‏.

Is inflation good for the economy? In a word, yes. But, it is essential that organizations like the Fed keep a close eye on its status and make the necessary adjustments

The hyperinflation in the Weimar Republic of Germany is a notable example‏.

‏[edit] Related definitionsThe term "inflation" originally referred to increases in the amount of money in circulation, and some economists still use the word in this way. However, most economists today use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called price inflation.[23] Economists generally agree that in the long run, inflation is caused by increases in the money supply.[24‏]

Other economic concepts related to inflation include: deflation – a fall in the general price level; disinflation – a decrease in the rate of inflation; hyperinflation – an out-of-control inflationary spiral; stagflation – a combination of inflation, slow economic growth and high unemployment; and reflation – an attempt to raise the general level of prices to counteract deflationary pressures‏.

Since there are many possible measures of the price level, there are many possible measures of price inflation. Most frequently, the term "inflation" refers to a rise in a broad price index representing the overall price level for goods and services in the economy. The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflator are some examples of broad price indices. However, "inflation" may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy, such as commodities (including food, fuel, metals), financial assets (such as stocks, bonds and real estate), services (such as entertainment and health care), or labor. The Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. Core inflation is a measure of inflation for a subset of consumer prices that excludes food and energy prices, which rise and fall more than other prices in the short term. The Federal Reserve Board pays particular attention to the core inflation rate to get a better estimate of long-term future inflation trends overall.[25‏]

‏ ‏[edit] Measures‏

CPI inflation (year-on-year) in the United States from 1914 to 2010.Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer Price Index.[26] The Consumer Price Index measures prices of a selection of goods and services purchased by a "typical consumer".[4] The inflation rate is the percentage rate of change of a price index over time‏.

For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.[27‏]

Other widely used price indices for calculating price inflation include the following‏:

Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing

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