Bad news about prices in the grocery store.

Historically high inflation.

In 2022, much of the world experienced a period of uncommonly high inflation, with the U.S., U.K. and Eurozone all peaking at around 10%, meaning that prices on average were a full 10% higher than one year before.

Though that's probably not a surprise to anyone watching this.

It's thankfully now closer to the normal range, if still a bit high.

But infuriatingly, since this chart just shows a rate of change, that doesn't mean that prices are down.

Just that they've stopped climbing as fast.

And that really sucks.

Consumers are stressed, businesses are suffering and governments are scrambling.

But at the same time, if you were to, I don't know, find yourself reading and watching a ton of inflation-related content, you'll also keep hearing this.

A little inflation is a good thing.

A little inflation is a good thing.

A little inflation now would be a good thing.

Everybody wants a little inflation.

Why?

If rising prices hurt seemingly everyone, why can't they just stay the same?

Why can't inflation be zero?

The first reason inflation can't stay at zero is because governments and their central banks don't want it to.

Lots of countries actively pursue what is called an inflation target.

In the U.S. right now, it's about 2%.

That's the number that's used by most central banks across the world.

But the truth of it is, that's a pretty arbitrary number.

The goal is what economists consider a virtuous cycle.

Here's what that looks like.

In times when prices are generally rising, people tend to expect them to rise further.

And that actually encourages people to spend money now, on big durable purchases like cars or appliances, in order to avoid having to pay more for the same thing later.

And the stuff we need to buy no matter what, goods like food or clothing, gets more expensive too, which requires us to spend more.

Either way, companies make more money, which means more people have jobs and more of their own money to spend.

And that means more demand and therefore higher prices.

So the cycle continues.

But this bit of a cycle is crucial to its virtue.

It's okay if prices rise so long as wages rise too.

You'll still be able to afford the same goods if your wages keep pace with inflation.

Emphasis on the if.

In the U.S., for two years, wage growth lagged behind inflation.

That trend has reversed, starting in mid-2023.

Wages, especially at the bottom, have kept up with inflation.

In fact, in many cases surpassed inflation.

And that is a good thing, that also we have to remember, wages in this country are rock bottom and have been for way, way too long.

Right?

So wage growth rising, good.

Are wages high enough?

No.

And a disruption at any point in this loop can lead to the kind of high inflation we've experienced over the past few years.

When supply chain interruptions created product shortages.

And some companies artificially drove up prices to increase their profits.

Which, along with some other causes, effectively turned this virtuous cycle into a vicious one.

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The government does have tools to combat rising inflation.

They usually shift things here, by raising interest rates, which makes all borrowing, including credit cards and bank loans, more expensive.

When the cost of borrowing goes up, it becomes more expensive to make investments, to hire people, and that eventually slows the economy down.

That's what the U.S. Federal Reserve did in 2022, which did help bring inflation closer to that 2% target, while placing an even higher financial strain on families who may need to borrow just to make ends meet.

When the Fed uses interest rates to bring down inflation, what they're doing is tamping down that demand, right?

They're telling people, you can't have a job.

Let's put you out of work so that demand slows, that price growth slows.

The Fed raises interest rates to slow down spending across the economy, partly by signaling to markets that they're taking the problem seriously, which creates an expectation that inflation will fall.

But we also have to talk about what happens when prices fall instead of rise.

That's called deflation.

And falling prices honestly sounds pretty good.

But they can also introduce another kind of cycle.

A deflationary spiral.

When prices fall, consumers may hold off on making big purchases, hoping for even lower prices in the future, and the stuff we need costs less, so we just spend less in general.

If people are spending less, companies make less.

They start to cut costs.

And ultimately, they lay off employees.

Unemployed people spend less, and even the people who are employed might choose to save more to stave off financial loss.

So prices go down even further as demand goes down.

So ultimately, all of that adds up to slower economic growth as a whole.

Which is really hard to fix, because governments don't have the same ability to respond to deflation as they do to inflation.

Look at this chart again.

The last time inflation dipped below 2% in spring of 2020, the US brought interest rates all the way down to 0.05%.

And after bottoming out for a bit, that seemed to work.

Inflation inched back up.

But if inflation hadn't come back up, the government would have had limited options.

Their rates were already getting almost at zero.

And then things could get dicey.

Historically, periods of true deflation are pretty rare.

But when they do happen, it seems that fixing them requires a pretty serious shock to the economy.

The Great Depression was in part a deflationary spiral, solved only by the outbreak of World War II, when the government supercharged spending and employment.

And Japan is finally emerging from decades of chronic deflation.

But that's thanks, in no small part, to the high inflation that most of the world battled over the last few years.

You don't want to rely on those kinds of things.

If inflation goes below zero, it is hard to fix.

The cost of deflation is really high, and that's something that we want to avoid.

This is where inflation targets commit.

Let's look at this chart again.

These lines are pretty shaky, because there are a lot of really complicated factors that affect inflation.

The macroeconomy is made up of the decisions of millions of people, of millions of businesses.

The way those decisions interact, I mean, try thinking about how to map everything out.

And it's just, it's mind-blowing, right?

Inflation will always fluctuate, even if it's just a little.

And this is the last big reason why they don't want inflation to be zero percent.

If inflation sits here, that basic shakiness is constantly at risk of dropping down into the deflation zone, triggering the bad cycle.

And the way to prevent that is to have it sit just a little bit higher.

So...

A little inflation is usually a good thing.

Yeah.

That's annoying.