Is inflation really necessary?
- Pratik Modi
- Aug 10, 2024
- 4 min read
Updated: Oct 17, 2025
In this article, we examine that if high inflation hurts everyone, we can't we have zero inflation? We also take a look at that is a deflationary spiral in depth.
In 2022, much of the world experienced a period of uncommonly high inflation. With the US, UK and Euro Zone, all peaking at around 10%. Meaning that prices on average were a full 10% higher than one year before. Though, that's probably not a surprise to anyone reading this. It's thankfully now closer to the normal range, if still a bit high.
But infuriatingly, since this chart just shows a rate of change that doesn't mean that prices are down. It just means that they have stopped climbing as fast. Consumers are stressed, businesses are suffering and governments are scrambling. But then why do people keep saying that a little inflation is a good thing?
WHY?
If rising prices hurt seemingly everyone, why can't they just stay the same? Why can't inflation be stay at zero? The first reason is that because governments and their central banks don't want it to. Lots of countries actively pursue what is called an Inflation Target.
Country | Inflation Target Rate |
|---|---|
US | 2% |
UK | 2% |
Eurozone | 2% |
China | 2% |
India | 4% |
The goal is what economists consider a virtuous cycle. In times when prices are generally rising, people tend to expect them to rise further and that actually encourages people to spend money now on big durable purchases like cars or appliances in order to avoid having to pay more for the same thing later and the stuff we need to buy no matter, 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 and 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 so long as wages rise too. You will still be able to afford the same goods IF your wages keep pace with inflation.
In the US, for 2 years, wage growth lagged behind inflation. That trend has reversed starting in mid 2023. A disruption at any point in this loop can lead to the kind of high inflation we have experienced over the past few years when supply chain interruptions created product shortages and some companies artificially drove up prices to increase their profits, which along with with some other causes effectively turn this virtuous cycle into a vicious.
To combat rising inflation, the Federal Reserve usually shift things by raising interest rates which makes all borrowing including credit cards and bank loans more expensive. When the cost of borrowing goes up, it becomes more expensive to make investments, or to hire people and that eventually slows the economy down. That's what the US Federal Reserve did in 2022, which did help 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 doing is tamping down that demand.
CHAPTER 2: DEFLATION
But, we also have to talk about what happens when prices fall instead of rising. That's called deflation, and falling prices sounds pretty good. But, 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 the stuff we need costs less so we just spend less in general. This is completely opposite of inflation. If people are spending less, companies make less, they start to cut costs and ultimately they lay off employees. Unemployed people spend less and even the people who are employed might choose to save more. So, prices go down even further as demand goes down.
Ultimately, all of that adds up to slower economic growth as a whole which is really hard to fix because governments don't have the same ability to respond to deflation as they do to inflation. In 2020, the last time inflation dipped below 2%, the US brought interest rates all the way down to 0.05% and after bottoming out for a bit, that seemed to work. Inflation inched back up. But, if inflation hadn't come back up, the government would have had limited options since their rates were already getting almost out zero.
Historically, periods of true deflation are pretty rare but when they do happen, fixing them requires a pretty serious shock to the economy. We have talked about Japan's struggle with decades of chronic deflation in another article. If inflation goes below zero, it is hard to fix and the cost of deflation is really high. This is where inflation targets come in.
The lines indicating inflation are pretty shaky because there are a lot of really complicated factors that affect inflation. The macroeconomy is made up of the decisions of millions of people and businesses, and the way those decisions interact. Inflation will always fluctuate even if it's just a little and this is the last big reason why we don't want inflation to be 0%. If inflation sits right at 0%, that basic shakiness is constantly at risk of dropping down into the deflation zone, triggering the bad cycle and the way to prevent that is to have it sit just a little bit higher. So, a little inflation is usually a good thing, even if its annoying.
