What Does The Inflation Rate Indicate?

What is the ideal inflation rate and why?

• I was looking at inflation rates, and in the US, there used to be periods of inflation and periods of deflation. It was just one of those things that was controlled by the market. The US hasn't been in a period of deflation for sixty years or so. Because if we start to lean toward deflation, the US treasury just lowers interest rates (which is fine with me) but if they think that isn't doing the trick, then the US mint just prints off a bunch of money to prevent deflation and keep that inflation going. In 2009, the inflation rate was somewhere around % 0.7 (3 times higher than interest people got from savings accounts). Anyway, %0.7 is not bad at all. Most years are worse. But still, considering we were in a recession it should have been closer to zero. I get pissed off because I was under employed for the first half of 2009. Everybody was complaining about the recession, unemployment, housing and credit crunch and prices of gas, but the US Treasury made bloody sure that inflation kept happening so we couldn't afford stuff. Isn't it called "Stagflation" when the economy has recession and inflation at the same time? Isn't that bad because we lose income from the recession AND at the same time we lose purchasing power from the inflation. So in 2009 we got less money and it was also worth less due to the Treasury. What the heck is that all about? Why does the US Treasury insist on inflation?

• Answer:

  Interesting topic. Manageable inflation is actually needed in order to facilitate economic growth. As an economy expands, so needs the money supply, so therefore the Fed, thru its open market operations (buying/selling treasuries), controls the expansion of money pumped into the economy. You've got a great question: "what is the ideal inflation rate". Inflation should actually trail the increase in value of goods and services that an economy produces. The problem is that we are no longer considerate of the traditional models of prices in determining the value of goods and services produced, which are mainly production costs + labor. We expect the markets to price a product, based on what the competition sells for. For example, a plasma tv. Does it really cost $2000 to design, manufacture, and distribute the product or is it just that all other plasma tv's set their prices around the same price? If actual product prices are based on the costs of production, then the supply/demand models will determine changes in value (prices) after which inflation will follow based on economic growth. But enough of textbook economics; lets talk about current events. Recently the Fed bought 2.55bln worth of treasuries to inject money in to the economy (this on top of 300bln in 2009 - and with another 20bln to go in the rest of 2010). The idea is to keep interest rate yields low. The reason for this is simple; they want you and me borrowing from the banks to spend and invest. Maybe buy that new car or maybe start your own business. Either way, to address the unemployment problem, we need to create jobs. The problem is that if there is slow to no growth due to credit restrictions (you or I cannot buy that new car because our credit is damaged) then it sets a dangerous risk for extreme inflation, or hyperinflation. Too much money out there, nothing being done with it. So the issue is not whether inflation is a bad thing, we actually need it, but the real problem lies in what do we do with the all the money that is available out there?