Is Inflation Good or Bad?

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Hi Taylor: Based on what I’ve been reading, I get the feeling that we’re both afraid of and in control of inflation. Am I right? Because that doesn’t really make sense to me. - Kira

Hey Kira: What a conundrum, right? If you type “Why is inflation” into your search bar, the top two autofills are probably going to be “good” and “bad.” We’re all apprehensive about it, but as long as the rate doesn’t get too high, and the rises and falls sort of match each other, inflation is just another tool of economics with pros and cons.

1. Pros. When you think about the economy, you have to look past jobs and GDP. Those are huge, significant markers, but the lending system has almost equal pull—as we learned the hard way back in 2008. Home, business, and personal loans serve as a massive pillar of commerce, heavily intertwined with our government as well as foreign governments. When inflation rises and gets close to or exceeds the current interest rate, borrowers can benefit. As a seller of bonds, our government can eliminate debt by selling bonds at an interest rate that starts higher but ends up being lower than the inflation rate. This can backfire when it comes to consumer confidence, but it’s something on the treasury department’s radar, especially when dealing with a deficit like the one we’ve got. Also worth considering: even if inflation makes people a little antsy, it creates a strong push toward buying and investing when rates come back down.

2. Cons. The main negative goes without saying. Should we get to the point where a soda costs $14, our money starts to feel useless and a lot of people struggle. If the dollar falls too far while the Yen or the Euro shoots up, our international leverage will suffer. You’ve probably heard stories of other countries (most notably Venezuela) where inflation has crippled the economy. There are no signs of that happening to us, but it’s the cautionary tale we need to be aware of.

3. Control. We fight inflation by raising interest rates and decreasing spending, so the government can pull the opposite levers in an attempt to inflate. Low interest rates (as we’ve had for a while) lead to extra spending. Coupled with the stimulus and other big government projects, inflation would be expected to rise. Then, should the inflation rate eclipse the 2% target, the Fed might step in to adjust rates and try to hit a little inflation reset.

As you can see, there are a lot of things at play when it comes to this issue. With our big, deserving country and economy, it’s not as simple as saying that inflation is bad and should be avoided, though it’s understandably a little frightening for many investors. Hope this helps!