Inflation, fiscal policy, and monetary policy
Ideally, economic inflation shouldn't be too hot or too cold.
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Transcript
Inflation. Thatâs a scary-sounding term for a basic fact of financial life: rising prices. It could refer to the price of a specific good or service, or to a general rise in the prices of all the things we buyâsmartphones, cars, haircuts, avocados, chew toys...you get the picture. Everything.
Is inflation good or bad? Like most things economic, it depends. A little bit of inflation isnât bad. Actually, itâs a sign of a healthy economyâa robust job market, confident consumers, and businesses that arenât afraid to innovate, invest, and hire.
But, yes, there can be too much of a good thing. If inflation rises too fast, like it did in the late 1970s and more recently amid the COVID-19 pandemic, increasing prices can wreak havoc on household and company budgets as things cost more. Wages may rise in response, but they tend to lag far behind costs.
As bad as runaway inflation is, though, the oppositeâdeflationâcan be even worse. Thatâs what happened during the Great Depression. When prices are falling, and are expected to keep falling, thereâs no incentive to buy, invest, or produce goods. People hang onto their money because they know stuff will be cheaper later. When companies canât sell their products, they also canât pay their workers. Rising unemployment makes the problem worse.
All economies have hot and cold periods, but the people in charge of the money flowâthe Treasury and the Federal Reserve Bankâkeep a careful eye on the temperature controls. To jumpstart a sagging economy, the Treasury will supply funds to businesses to encourage hiring and capital improvements. Theyâll even send checks to taxpayers to nudge consumer spending.
Meanwhile, the Fed tweaks its monetary policy to keep inflation close to its target rate of 2% per year. If inflation starts to sag, the Fed might reduce interest rates to encourage borrowing. If inflation starts to run hot, the Fed will raise rates to slow things down.
When it comes to inflation, youâll often hear experts mention Goldilocks. Economic inflation shouldnât be too hot or too coldâbut just right.
Is inflation good or bad? Like most things economic, it depends. A little bit of inflation isnât bad. Actually, itâs a sign of a healthy economyâa robust job market, confident consumers, and businesses that arenât afraid to innovate, invest, and hire.
But, yes, there can be too much of a good thing. If inflation rises too fast, like it did in the late 1970s and more recently amid the COVID-19 pandemic, increasing prices can wreak havoc on household and company budgets as things cost more. Wages may rise in response, but they tend to lag far behind costs.
As bad as runaway inflation is, though, the oppositeâdeflationâcan be even worse. Thatâs what happened during the Great Depression. When prices are falling, and are expected to keep falling, thereâs no incentive to buy, invest, or produce goods. People hang onto their money because they know stuff will be cheaper later. When companies canât sell their products, they also canât pay their workers. Rising unemployment makes the problem worse.
All economies have hot and cold periods, but the people in charge of the money flowâthe Treasury and the Federal Reserve Bankâkeep a careful eye on the temperature controls. To jumpstart a sagging economy, the Treasury will supply funds to businesses to encourage hiring and capital improvements. Theyâll even send checks to taxpayers to nudge consumer spending.
Meanwhile, the Fed tweaks its monetary policy to keep inflation close to its target rate of 2% per year. If inflation starts to sag, the Fed might reduce interest rates to encourage borrowing. If inflation starts to run hot, the Fed will raise rates to slow things down.
When it comes to inflation, youâll often hear experts mention Goldilocks. Economic inflation shouldnât be too hot or too coldâbut just right.