BASICS OF INFLATION AND THE EFFECT OF ZERO INFLATION IN AN ECONOMY

The word “inflation” came from latin word “inflatio” which means “blow into”. The Little Oxford Dictionary defines the abstract noun inflation which came from the verb “inflate” as “expansion of something by filling it up with gas”. But when the term comes to macro-economics, this means something different.

We all use the term inflation but many of us don’t know the basics of the inflation. Whenever the price goes up we say there must be high inflation coming up in our country or whenever we see some news on our television reporting high inflation, we instantly say that now the price is going to increase. So, now in this article, I will discuss about the basics of inflation at the beginning in a very simple language which will give an idea of inflation to the novice readers and later I will come to the subject of Zero inflation effect.

The simplest definition of Inflation is Inflation is either a rise of prices or fall in the value of the currency. That means inflation is an increase in the cost of things that are necessary for humans to live and enjoy life; such as bread, butter, rice, sugar, chicken, meat, cotton, electronics etc.

There are two major causes of inflation; some inflation is caused because the reserve bank of the country printed too much currency or experienced financial disaster causing its currency to plummet. Other sources of inflation can be rise in diesel or petrol or gas prices which results higher transportation costs. This makes shipping goods from one place to another more expensive which results increase in costs. So, to make profits manufacturers increase the price of the staple goods such as rice, wheat, toothpaste, sugar, chicken etc. At this point consumers demand to increase their pay at their workplaces because of the price-rise, and to increase the pay, companies prefers to pressure higher profits. To make higher profits companies again have to increase the price of their products and services. So, again rise of prices results more inflation. This is when economists call that “Inflation has embedded in the economy”.

 So, for any economy lowering the inflation is a prime motto alongside higher GDP and higher Per-Capita Income. There are different ways of controlling the inflation an economy adopts such as

1.   Monetary policy of the central bank
2. . Fixed Exchange Rate
3.   Setting Gold Standard
4.   Wage and Price Controls
5.   Indexing Income Tax
6.   Cost of Living Allowance

Keeping the title of this article in mind, I will not go in detail of the above mentioned points but I can simply say that if any economy does this effectively; inflation can be very well controlled.

Effect of Minimizing Inflation:

The dream of every economy is to minimize inflation. Ronald Reagon once said “Inflation is as violent as mugger, as frightening as armed robber and as deadly as a hit man”. Inflation can kill an economy in such a way, that an economy can dissolve, a currency can dissolve. The example of dissolving the Zimbabwean currency in 2009 is worth mentioning here. Even with the USD, the Zimbabwean economy is still struggling hard. We get all whatever we need in a developed economy when we control and minimize the inflation. Such as:

1.   Price Stability
2.     High Real Income 
3.   Employment
4.   Low risk in business
5.   High Interest Rates for FDs and Savings accounts from different financial institutions
6.   Lower Income Tax (If the monetary policy index the tax with the rate of inflation)
7.   Confidence of investors
8.   Rise of Stock Market Index
9.   Rise in return of bond and debentures 
10.    Affluent lifestyle of the population

So, controlling and minimizing inflation is the only medicine for an economy to sustain, grow and prosper.

The Zero Inflation Effect:

Most people believe that all the central banking institution of the world always try keeping a lid on inflation but most central banks in reality do not believe the concept of zero inflation because it is fundamentally flawed on many aspects. Let’s discuss those one by one:

1.     

1. The most obvious danger of too low or zero inflation is the risk of slipping into outright deflation, when prices of different products (especially staple products) persistently fall which becomes devastating on an economy as a whole
   
   
2. Zero inflation implies stability of spending only in a stationary economy. In a growing economy with more to be bought, stability of money spending requires falling prices. In an economy where productivity is declining, stability of spending requires that prices generally rise. In a globalized world like ours it is unconventional for a stationary economy to exist.Zero inflation has no use in a dynamic economy
   
3.  Zero inflation policy that would be arbitrary when productivity is improving could lead to disaster where productivity to fall significantly. Zero inflation would then require a forced concentration (via tight money) of spending to offset the normal tendency for the prices of scarcer goods to rise. Debtors would find their real income reduced but the amount of real income needed to repay the debts would be unchanged.

Thus we actually do not need a zero inflation policy. Most central banking institutions are aware of this, the economy of current times surely needs stable spending. It will result sustained improvements in productivity would necessitate falling prices; but these would not involve the bad side-effects usually associated with deflation. On the other hand, falling output would cause inflation of the price level, but without the poisonous effects of inflations stemming from excessive money injections.