A small but positive rate of inflation can be good for an economy

Opening Remarks I would begin by noting that as I, as the affirmative, have the burden of persuasion. However, I do have an advantage in that I need only show that inflation can be good for an economy. I need not show that it is good for all economies nor that it is good for a given economy under all circumstances. In this first round I will give three reasons why inflation can be good for an economy. First, I will make some general remarks about the types of economies I will be discussing. There are two general forms of currency: convertible and fiat. A convertible currency is backed by a commodity (such as gold) or can be exchanged for a foreign currency (like the Bahama dollar). A fiat currency is backed by nothing[1]. It derives its value from the willingness of people to use it and the requirement that government taxes be paid in that currency. I will be talking about an economy with a fiat currency where the nation is the monopoly issuer of its own currency (like the US, UK or Japan but not Eurozone countries). In countries like these, the money is purely a product of the state, and it can (within limits) be manipulated by the state to achieve desired ends. To drive economic growth a country must expand its ability to produce. That is, the more the country can produce per citizen, the more each citizen can consume. This is what determines prosperity at the national level, not money. How much of a country's own money the country has is largely irrelevant (there are some secondary transaction effects and the like) to the economic prosperity it experiences. Most money exists simply as numbers in a computer system[2]. The total amount of money a country has is just the sum of all those numbers in all those computers. Clearly increasing or decreasing the total will have no direct effect on the country's wealth. Wealth is determined by real goods and services. Thus, I will be describing how inflation can increase a society's ability to produce real goods and services. Point 1. Average positive inflation prevents periods of deflation In a dynamic market, price levels will naturally fluctuate around an equilibrium. As unexpected events influence aggregate supply or demand, prices will naturally change. Absent strict price controls, there is not much a central government can do to prevent such fluctuations. For example, a sudden increase in population will cause an increase in demand. A natural disaster that interferes with shipping will decrease production and thus supply. Technological advancements will have the opposite effect. Each of these effects will have short term effect on prices. Those periods that lower prices can cause periods of deflation. If, however, there is a background (fairly stable) rate of inflation then these situations cause a reduction in inflation rate without actually allowing the economy to go into deflation. Because it’s a necessary antecedent to my argument, I will briefly touch on why deflation is bad for an economy. Since the economic health of a society is dependent on the amount of real goods and services that can be produced, to grow an economy means to invest in increased production. When an economy goes into deflation, holding cash becomes a profitable “investment” since it will be exchangeable for more real goods in the future. This effect reduces investment in otherwise profitable projects. Additionally, deflation means nominal wages have to fall in addition to prices. Since there is resistance to cutting wages (contracts and the like) the only way to have a decrease in aggregate wages is to have a rise in unemployment. Point 2. Inflation encourages investment over saving Money sitting in bank accounts or cash in a safe does not stimulate the economy. Construction of new factories and research into better production methods do. A small level of inflation discourages hording of money and encourages the holding of assets, either through outright purchase or by financing their creation. It is this creation of new assets, which in turn produces more goods, that grows the economy. Point 3. Inflation is caused by a growing economy Inflation (in a sovereign currency) is naturally caused by a growing economy. Central governments should not seek to prevent this. Generally speaking, a company needs to pay its costs (materials and labor) prior to receiving payment for finished goods. If a company expands (either by hiring more people or paying more for higher skills) it has increased the total demand in the economy (those new or higher paid workers will want to buy things). However, the new goods they are producing have not yet come on the market. Now imagine a similar phenomenon across the economy as a whole – companies are expanding and producing more. This causes a temporary jump in prices. Once the new goods come on the market, prices stop rising, having reached a new equilibrium. If, however more businesses expand, that will push prices up again. If businesses are expanding continuously, the price rise will be continuous and we have inflation. Yes, if businesses expand too rapidly, you can have a bubble. However, not all expansions are bubbles. If there were never an expansion, we would all still be tilling our own farms, and there would be no cars or iphones. References [1]Greg Mankiw Principles of Economics 659 . http://books.google.com... [2]. http://www.pbs.org... [3] . http://krugman.blogs.nytimes.com... (cited for the internal quotes, not the author’s opinion)