Why do we want low and stable inflation?

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Norges Bank

Norsk（https://www.norges-bank.no/kort-forklart/inflasjon/hvorfor-bor-inflasjonen-vare-lav-og-stabil/）

Explainers

Explainer

Why do we want low and stable inflation?

Both rapidly rising and falling prices can pose challenges to the economy. The best course of action is therefore to aim for something in between.

What is the problem with high inflation?

High inflation over time has a tendency to become entrenched and self-reinforcing. In extreme cases, a self-reinforcing wage-price spiral can lead to hyperinflation, where prices rise rapidly over a short period. In the worst case, confidence in the value of money may disappear.

When inflation is high, it also tends to be more variable. Uncertainty about the inflation outlook increases. When both households and firms become uncertain about their future income and expenditure, economic planning becomes more difficult.

Inflation can also have unintended distributional effects. High inflation can erode purchasing power, which hits hardest those with low incomes and small margins. People with savings will notice that the value of their savings declines.

Deflation: What is the problem with falling prices?

The opposite of inflation is called deflation and means a persistent fall in the general price level. Money increases in value. Strangely enough, this is not a good thing.

The problem with deflation is that it is usually associated with economic downturns. Deflation can in and of itself also trigger a fall in demand, because people put off buying something that they think will be cheaper in the future.

At the same time, the real value of debt becomes ever greater. Higher debt burdens reduce household demand and business profitability. In the worst case, this can lead to a negative spiral where economic activity eventually comes to a halt.

Why can’t we have zero inflation and unchanging prices?

If prices do not change at all, there is neither inflation nor deflation. But in practice, it is difficult to maintain an unchanging price level over time, because the economy is constantly evolving.