Moderate Inflation

Is it possible for inflation to actually be a good thing? It's known that when people hear the word inflation, they might get a bit apprehensive. After all, inflation decreases the value of money and makes prices go higher so why would anyone like it? Well, as it turns out, inflation can actually be beneficial to society! To learn about the benefits of moderate inflation, effects, the relevance of it, and more, keep reading on!

Moderate Inflation Definition

Moderate inflation, also called mild or creeping inflation, is when prices climb steadily over a certain time at a slow rate. It raises consumer expectations that the prices of goods and services will continue to rise, which ends up boosting demand. Consumers will make immediate purchases to avoid the increased future prices. Moderate inflation fosters economic growth in this way.

Types of Inflation

There are four main types of inflation that usually get the most attention. These are:

• Moderate inflation (aka Mild inflation, Creeping inflation) - this is a case in which a country's inflation rises slowly but steadily over time, with the effect of inflation being apparent only after a lengthy period of time. Inflation does not go higher than 3% in the course of a year.
• Walking inflation - This happens when costs grow gradually and the yearly inflation rate is in the single digits. The pace of price growth is usually between 3 and 10 percent.
• Galloping inflation - This is when an economy's prices are rising at a fast pace and usually reach an inflation rate of over 10% within one year. It is frequently a precursor to hyperinflation.
• Hyperinflation - This is when an economy sees quick, extreme, and out-of-control price rises. This inflation causes inflation rates that often exceed 50% per month.

Figure 1 below shows different types of inflation and the corresponding changes in price levels that would occur over time.

Fig 1. - Types of inflation

Benefits of Moderate Inflation

There are several benefits to moderate inflation.

For example, in the case that there is underutilized labor or supplies, inflation can potentially assist in improving output. How so? Well, when inflation takes place, more money is needed to buy the same things. The more money that is needed means that people will expect more increases in prices so they want to spend more in case prices go up again, and this in turn creates greater demand. More demand, in turn, leads to more production to supply that need.

Moderate inflation also allows prices to adapt and for products and services to reach their true value. Why is this good? Well, prices will get updated to more accurately reflect what's needed to cover running costs and allow profit at the same time, which is good for those who are selling products and services. Also, employers will increase the salaries and wages of those working for them so as to keep up with the moderate inflation rate, and this benefits the employees.

Inflation rates that are moderate are indicative of a thriving economy. As long as inflation is going up at a moderate pace and wages are also increasing in order to keep up with the inflation, then moderate inflation is a sign of a successful society that is regularly adjusting its economic policies to satisfy the needs of its residents.

Moderate inflation vs deflation

Also, all things considered, moderate inflation is better for the economy than the opposite - deflation. Deflation is defined as a broad decrease in the price of products and services.

Moderate Inflation Example

Let's take a look at an example of moderate inflation in the United States.

Table 1: U.S. Interest Rates 2015-2018 - StudySmarter. Source: WorldBank¹

As seen in Table 1 above, the inflation rate from 2015 to 2018 rose steadily. From 2015 to 2016, the inflation rate rose by 1.14%; from 2016 to 2017 it rose by 0.87%; from 2017 to 2018 it rose by 0.31%. Several years in a row, the inflation rate rose steadily and never went over 3% in a year. This is a perfect example of moderate inflation. By rising just a bit every year, it's easier to pinpoint by how much it will raise next year and it keeps the economy thriving.

Causes of Inflation

There are typically three main causes of inflation.

These are known as:

• demand-pull
• cost-push
• built-in

Demand-pull

Demand-pull inflation happens when a rise in the availability of money causes an economy's total demand for products and services to rise faster than the capacity of production within the economy. Since people have more access to money, they spend more, and consequently the prices go up. Basically, it creates a high demand with less supply which causes the prices to rise.

Cost-push

Cost-push inflation is inflation triggered by increases in the pricing of things like labor, resources, and so on. The higher cost of labor, land, and other factors of production reduces the supply of these items. While demand remains steady, commodity costs rise, leading the overall cost level to rise. Numerous circumstances such as natural catastrophes or resource depletion, change in currency rates, and so on might all contribute to cost-push inflation.

Built-in

Built-in inflation is linked to expectations of inflation, or the belief that present inflation rates will persist in the foreseeable future. Workers and non-workers alike learn to assume that if the price of products and services increases, they will keep climbing at a similar rate in the future and therefore they demand higher salaries to maintain their quality of living.

Effects of Moderate Inflation

Let's go over some of the effects of moderate inflation:

Stability

With moderate inflation, the rate of future inflation is usually known because they're compared to the trend of inflation rate rises over the years. With this knowledge, companies can forecast future expenses and consumers can forecast future pricing.

In the case of moderate inflation, it can be good if the salaries rise along with the rate of inflation. However, if the wages don't increase at the same time, employees are actually working the same job for less pay. In this way, employers can actually reduce the amount they pay less efficient workers just by not increasing their salaries to match the rate of inflation.

Falling value of debt

Moderate inflation diminishes the real cost of debt. Inflation, by definition, makes the price of money fall over time. Essentially, money today is more valuable than money tomorrow. As a result of moderate inflation, debtors might repay lenders with money that is valued less than it was at the time that they borrowed the money.

Relevance of Moderate Inflation

The relevance of moderate inflation is clear. Moderate levels of inflation are often regarded as indications of a strong economy. How so? Well, when the economic growth rises, so does the demand for goods. This rise in demand raises prices a bit as manufacturers strive to produce more of that which is in demand. Employees profit because economic booms increase demand for work, and consequently salaries rise with the demands for work. Ultimately, these higher-paid workers go around and purchase more goods, and this keeps going around and around in a circle.

However, when inflation rates get to be too low or high, this can be dangerous for the economy.

Low inflation typically indicates that demand for products and services has become lower than it ought to be, which slows economic growth and lowers wages. This lack of demand may even result in a recession with increased unemployment.

However, excessive inflation can bring about similar issues. If left uncontrolled, inflation might skyrocket, causing the economy to stagnate swiftly and unemployment to rise. Rising inflation and unemployment are known as stagflation. It may be a challenge for governments to solve stagflation because most activities aimed at lowering inflation might very well increase unemployment, while measures aimed at lowering unemployment might aggravate inflation.