Inflation describes a situation where prices tend to rise. The Federal Reserve targets a gradual rate of inflation in the long-run. It believes that a slow increase in price level can help keep business profitable. It also prevents consumers from waiting for lower prices before making purchases. As per Kavan Choksi, inflation may erode the real value of debt over time. As a result, several types of borrowers, including businesses, may find it easier to repay loans as their nominal income grows with inflation, which lowers the real debt burden.
Kavan Choksi provides a brief insight into when is inflation good for the economy
If an economy is not running at capacity, it would mean that there are unused resources or labour. Theoretically, inflation may help increase production. After all, more dollars in circulation can translate to higher spending, which would eventually lead to more aggregated demand. Higher demand essentially triggers more production to meet that demand. As per a British economist, a certain level of inflation might be needed in the economy to prevent the Paradox of Thrift. This paradox tends to state that if consumer prices are allowed to consistently fall because their nation is becoming too productive, there is a chance that consumers may learn to hold off their purchases to wait for a better deal. The net effect of this paradox is to lower aggregate demand. This will mean less production, more job cuts and a faltering economy.
When there is moderate inflation, businesses might be more likely to invest in assets, research and development, or infrastructure. After all, the return on these investments may outpace inflation. On the other hand, during periods of low inflation or deflation, companies are likely to be more hesitant to invest, which may limit growth and innovation.
As per Kavan Choksi, inflation does make things easier for the debtors. They may have to repay their loans with money that is less valuable than the money they borrowed. This trend does encourage more lending and borrowing, which ultimately boosts spending. For instance, in case a debtor has $10,000 of debt during an inflationary period, this debt shall have less worth as time progresses. It shall be more beneficial to gradually pay off this debt during highly inflationary periods from a purchasing standpoint, owing to its diminishing value. Homeowners that have agreed to long-term, fixed mortgages especially are likely to benefit from inflation. Higher rates generally end up pushing prospective buyers out of the market. As a result, the ones in greater financial positions have higher chances to benefit from the diminished housing market. Individuals who have tenure at their jobs or are in more secure positions often benefit in an inflation, due to the slowing economy.
When inflation is high, the purchasing power of the currency of the country tends to weaken against other international currencies. This might end up causing downward pressure that strengthens the value of international currencies in relation to the inflationary currency. The people who own foreign currency that take advantage of favourable exchange rates have particularly higher chances of benefiting from inflation in another country.