2022 was the year of inflation. It seemed like the topic of inflation was everywhere, from your local news station to major international newspapers, and there was a legitimate reason behind this.
In 2022, the entire world was dealing with uncommon levels of inflation, with the US, and UK, and Euro Zone peaking at around 10%, meaning that prices in these places were on average 10% higher than they were a year prior.
Fast forward to now, and inflation has slowed down. However, price increases have not completely stopped. Inflation slowing down simply means that prices are increasing at a slower rate. So, does this mean that governments need to do more to completely stop inflation?
Not exactly. See, some inflation is actually a good thing. While governments want to keep inflation in check, they do not want to completely stop it. Governments actively pursue an inflation target. This refers to a specific level or range of inflation that a central bank aims to achieve and maintain over a certain period. In many countries, this target is around 2%.
So why is this target not 0%? And why is a little inflation beneficial for the economy?
In an ideal economic environment, a moderate level of inflation creates a positive feedback loop known as the virtuous inflation cycle. When this cycle kicks off, it is designed to stimulate economic activity, foster investment, and promote overall economic health.
Here’s how it works: a moderate level of inflation lets people know that prices for goods and services will increase in the future. This encourages consumers to spend rather than save, because when people expect prices to rise gradually, they are more likely to make purchases sooner rather than later.
Think of a house. You know that the price of a house you are looking to buy will increase over the next few years. You will try to buy it as soon as possible because it means you will buy it at a lower price.
With higher consumer spending, companies experience increased revenues and profits. This financial health enables businesses to continue investing in growth in order to attract even more consumers to their products and services.
As businesses expand and demand for goods and services increases, more jobs are created. Higher employment levels lead to increased household incomes and higher wages for employees.
Now more people have more money to spend, so the entire cycle will repeat, driving even more economic growth.
However, a disruption at any point of this loop can lead to various problems.
Think about it. Price increases are okay as long as worker wages keep up with inflation. If inflation consistently outpaces worker wages, it means that people will have less money to spend on more expensive products and services, which will ultimately halt the economy.
Disruptions in this cycle could also lead to the high rate of inflation we saw in 2022. For example, disruptions in the global supply chain led to fewer products being produced and sold, which leads to rapid price increases for the limited supply. Or, companies wanting to capitalize on the situation might want to further increase their prices, leading to even higher inflation.
But some inflation is also beneficial because it reduces the real value of debt. For borrowers, inflation means that the real value of the money they repay in the future is less than the value of the money they borrowed. In other words, the amount they repay can purchase fewer goods and services than the amount they initially borrowed could. This effectively reduces the real burden of debt.
In addition to inflation, we have deflation, which refers to the decline in prices over a period of time. While declining prices sound like a good thing, deflation can actually be more dangerous than inflation.
See, on the opposite side of the virtuous inflation cycle, we have the deflation spiral. A deflation spiral is a dangerous economic phenomenon characterized by a self-reinforcing cycle of falling prices and declining economic activity. This cycle could lead to severe economic downturns as each phase of deflation exacerbates the next.
When consumers know that prices will fall down, they hold off on their purchases. Why purchase something today when you know it will be cheaper in the future?
With reduced consumer spending, businesses experience lower sales and revenues. Lower prices can squeeze profit margins, making it harder for businesses to cover their costs and remain profitable.
Facing lower revenues and uncertain future demand, businesses cut back on investments in new projects, technology, and expansion. Businesses may also reduce production, leading to layoffs and higher unemployment. And higher unemployment leads to lower household incomes and lower wages, which further reduces consumer spending, creating this spiral that can completely halt economic growth.
Deflation also increases the real value of debt. Deflation means that the real value of the money borrowers repay in the future is more than the value of the money they borrowed. In other words, the amount they repay can purchase more goods and services than the amount they initially borrowed could. This effectively increases the real burden of the debt.
Deflation is often considered more dangerous than inflation because it is more difficult to control.
When talking about inflation, governments have several tools at their disposal to rein it in, and none of those tools is more powerful than interest rates. Central banks can increase the interest rates, which makes borrowing more expensive and saving more attractive.
This reduces consumer spending and business investment, cooling down the economy. This is effectively how countries dealt with high inflation in 2022.
However, when we talk about deflation, this is much more difficult to do. When inflation nears 0%, central banks can cut interest rates, making it cheaper to borrow money, which should increase consumer spending and business investment.
However, if inflation dips below 0% and we enter deflation, interest rates become almost useless. Central banks can only decrease interest rates to 0%. They cannot go below zero because that poses several other challenges and risks.
This is where inflation targets come in. As we can see from this graph, inflation over the past few years has been pretty shaky. The macroeconomic landscape is made up of millions of complicated factors and decisions that interact with each other, which make it difficult to keep a very steady rate of inflation.
This inflation fluctuation is why governments do not target a 0% inflation rate. If inflation sits here, the fluctuations would be a constant threat because a small dip in economic activity would push prices down and engage the deflationary spiral.
Having a small rate of inflation provides governments with enough time to respond to a possible slowdown in economic activity in a timely manner and prevent the deflationary spiral from kicking off.
All of these are reasons why some inflation is actually a good thing.
Source: MBA Maven
WORD BANK:
inflation /ɪnˈfleɪ.ʃən/ [B2] (n): lạm phát
legitimate /ləˈdʒɪt̬.ə.mət/ [C1] (adj): chính đáng
fast forward to now /fæst ˈfɔːr.wɚd tu naʊ/ (phrase): quay trở lại hiện tại
keep sth in check /kiːp ɪn ʧek/ (phrase): kiểm soát cái gì, giữ cái gì trong tầm kiểm soát
pursue a target /pɚˈsuː ə ˈtɑːr.ɡɪt/ [B2] (phrase): theo đuổi một mục tiêu
feedback loop /ˈfiːd.bæk luːp/ (n): vòng lặp phản hồi
virtuous /ˈvɝː.tʃu.əs/ (adj): lành mạnh
kick off /kɪks ɔːf/ (v): bắt đầu, khởi phát
stimulate sth /ˈstɪm.jə.leɪt/ [C1] (v): kích thích cái gì
foster sth /ˈfɑː.stɚ/ [C1] (v): thúc đẩy, nuôi dưỡng cái gì
promote sth /prəˈmoʊt/ [B2] (v): xúc tiến, thúc đẩy cái gì
purchase /ˈpɝː.tʃəs/ [B2] (v/n): mua
revenue /ˈrev.ə.nuː/ [B2] (n): doanh thu
drive sth /draɪv/ (v): thúc đẩy cái gì
disruption /dɪsˈrʌp.ʃən/ [C1] (n): sự gián đoạn
outpace sb/sth /ˌaʊtˈpeɪs/ (v): vượt qua, đi nhanh hơn ai/cái gì
ultimately /ˈʌl.tə.mət.li/ [B2] (adv): cuối cùng
halt sth /hɑːlt/ [C1] (v): dừng lại, làm ngưng lại cái gì
supply chain /səˈplaɪ ˌtʃeɪn/ (n): chuỗi cung ứng
capitalize on sth /ˈkæp.ɪ.təl.aɪz ɑːn/ [C1] (phrase): tận dụng cái gì
debt /det/ [B2] (n): khoản nợ
deflation spiral /dɪˈfleɪ.ʃən ˈspaɪ.rəl/ (n): vòng xoáy giảm phát
phenomenon /fəˈnɑː.mə.nɑːn/ [C1] (n): hiện tượng
characterized by sth /ˈker.ək.tɚ.aɪzd baɪ/ (phrase): được đặc trưng bởi cái gì
self-reinforcing /ˌself.riː.ɪnˈfɔːr.sɪŋ/ (adj): tự củng cố
severe /səˈvɪr/ [B2] (adj): nghiêm trọng
economic downturn /ˌek.əˈnɑː.mɪk ˈdaʊn.tɝːn/ (n): suy thoái kinh tế
phase /feɪz/ [B2] (n): giai đoạn
exacerbate sth /ɪɡˈzæs.ɚ.beɪt/ [C2] (v): làm trầm trọng thêm cái gì
hold off on sth /hoʊld ɔːf ɑːn/ (phrase): trì hoãn làm gì
squeeze sth /skwiːz/ [C1] (v): bóp nghẹt cái gì
profit margins /ˈprɑː.fɪt ˌmɑːr.dʒɪnz/ (n): biên lợi nhuận
profitable /ˈprɑː.fɪ.t̬ə.bəl/ [B2] (adj): có lợi nhuận
cut back on sth /kʌt bæk ɑːn/ (phrase): cắt giảm cái gì
layoffs /ˈleɪ.ɑːfs/ (n): sự sa thải lao động
initially /ɪˈnɪʃ.əl.i/ [B2] (adv): ban đầu
at one’s disposal /dɪˈspoʊ.zəl/ (phrase): sẵn trong tay ai để sử dụng
rein sth in /reɪn ɪn/ (v): kiềm chế cái gì
interest rate /ˈɪn.trəst ˌreɪt/ [B2] (n): lãi suất
pose /poʊz/ [B2] (v): gây ra (nguy hiểm, thách thức)
come in /kʌm ɪn/ (phrasal verb): phát huy tác dụng
shaky /ˈʃeɪ.ki/ [C1] (adj): biến động, không ổn định
the macroeconomic landscape /ˌmæk.roʊˌek.əˈnɑː.mɪk ˈlænd.skeɪp/ (n): bức tranh kinh tế vĩ mô
complicated /ˈkɑːm.plə.keɪ.t̬ɪd/ [B2] (adj): phức tạp
a constant threat /ˈkɑːn.stənt θret/ (n): mối đe dọa thường trực
dip /dɪp/ [C1] (n): sự sụt giảm
deflationary /ˌdiːˈfleɪ.ʃən.er.i/ (adj): thuộc về giảm phát
timely /ˈtaɪm.li/ [C1] (adj): kịp thời
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