Understanding how inflation affects our economy is key to grasping how our system truly works. However, the first step in this process, though, is learning more about the general nature of inflation.
Inflation occurs when the value of money begins to fall, thereby decreasing purchasing power. There are a number of ways to measure inflation in the United States, and it is worth noting that inflation is greatly different from currency devaluation. The primary symptom of inflation is a rise in prices of consumer goods.
While many would suggest that the lower the rate of inflation, the better the market is for consumers, this simply isn't the case. In fact, you may have recently heard members of the federal government suggesting that they will use resources like the central bank to create and maintain certain levels of inflation as necessary for our economy. Former Fed Chair Greenspan even said that a fall in inflation rates would ruin our economy as a whole.
Excessive inflation, though, can be as problematic as the deflation process. The larger the system gets, the more imaginary profits are created. This creates a kind of bubble around a particular market. Thrifty spending is discouraged, debt is encouraged, and when the bubble finally comes crashing to Earth, billions are lost in investment dollars.
Inflation Policies in the United States
The Fed keeps a tight rein on both inflation and deflation, trying to create a happy medium that encourages moderate economic growth for the United States. As a result, there are several policies in place to deal with inflation (or deflation as the case may be). The Fed watches a number of things carefully to help determine the inflation policies for the country. One of their primary tools is the consumer price index. By examining the price of goods on a general level, the Fed can make decisions about whether or not to raise interest rates in an attempt to keep the market on a relatively stable level. By changing the level of the interest rate in the United States, the Fed can keep a tight rein on the level of inflation.
Every six weeks, the Federal Reserve Board of the Open Market Operations Committee (FOMC) meets to set both the Fed funds rate and the discount rate, changing the inflation levels each time the rates go up or down. Policy makers as a whole tend to either be more concerned with the growth of the GDP or more concerned with keeping the levels of inflation quite low within the country. It tends to be best to have a mixture of these two things at any given time in the Fed in order to set the best inflation
policies for the United States.
Is inflation good for the economy? In a word, yes. But, it is essential that organizations like the Fed keep a close eye on its status and make the necessary adjustments.