<blockquote>
<p>I wonder: Why is inflation or deflation &quot;necessary&quot;?</p>
</blockquote>
<p>Theoretically speaking its not necessary.  Theoretically central bank could just follow monetary policy rule that would keep inflation 0 at all times.</p>
<p>Practically however this would be extremely difficult since in real life managing inflation is difficult task. Let me give you analogy; theoretically it would be possible for you to always keep weight 80kg if you manage your calorie intake with infinite precision, but in real life you would most likely not be able to do that and your weight would sometimes over and sometimes under shoot.</p>
<p>The job of central bank is even more difficult. At present we are unable to generate data in real time. Most macroeconomic data that central bank needs are generated with lag (e.g. unemployment, GDP, inflation expectations etc). What even worse, even when data on GDP etc are published they are often being revised. For example, it might take up to 5 years and several rounds of revisions for us to discover what the  'correct' GDP for last quarter of 2021 was, and I am putting the word correct in scare quotes because even the final revision for GDP will have some measurement error.</p>
<p>As a consequence I do not believe any central bank can practically always deliver 0 inflation. They could do that on average in long term but not every single quarter forever.</p>
<p>However, having zero inflation is not necessarily desirable.</p>
<blockquote>
<p>And why is the one better than the other (is it?)?</p>
</blockquote>
<p>Because prices and wages are rigid (sticky) for various reasons. There are numerous reasons for wage and price stickiness for complete overview you can have a look at some textbook such as Mankiw Macroeconomics or Blanchard et all macroeconomics. Two important reasons worth while mentioning are minimum wage laws, or union industry-wide wage setting through bargaining (like in Germany).</p>
<p>These create wage rigidities because they usually specify so fixed minimum wage for everyone or for some industry. However, for healthy economy it is necessary that <em>real</em> wages sometimes decline (e.g. when there are negative productivity shocks like during major recessions etc).</p>
<p>When inflation is equal to 0 real wage decline requires that countries either lower their minimum wages or unions negotiate lower wages. This is extremely difficult and painstaking process.</p>
<p>Inflation solves this issue since despite minimum wages or union negotiated contracts stay exactly as they were previously, higher inflation means that real value of those wages drops even though employees still get paid same amount of money. This helps to prevent deep recessions with high level of unemployment (such as Great Depression that was caused precisely because of deflation/lack of inflation see discussion in Monetary History of the US by Friedman and Schwartz).</p>
<p>Hence moderate level of inflation (most economists believe its about 2% on average over the course of business cycle and only very few economists would say its outside 0.5-4% range) can be viewed as a grease that helps the cogs of economy turn. On other hand deflation makes sticky wages problem worse as deflation increases real wages. This can be extremely damaging during the times of recession, in fact this is what made depression of 1929 into Great Depression. So deflation can be viewed as a sandpaper that would clog the gears of an economy.</p>
<blockquote>
<p>Can't we raise wages (and the like, whatever this would be) to eliminate inflation</p>
</blockquote>
<p>No. Inflation is <em>by definition</em> change in consumer price level. To eliminate inflation you have to stop consumer goods from increasing in price.</p>
<p>I know of no economic theory where increase in wages would somehow reduce price of goods and services. In fact exactly the opposite. Raise in wages will likely lead to more inflation because higher wages mean goods are more expensive to produce so stores have to charge higher prices to pay for higher wages.</p>
<blockquote>
<p>If not, then the working people will simply loose salary more and more over time, right?</p>
</blockquote>
<p>They do not loose salary, their salary will loose purchasing power over time. Those are not the same things even though their practical welfare effect might be the same.</p>
<p>However, aside the above mentioned technicality, yes inflation continuously erodes real wages of workers.  This is not a bug, its a feature as mentioned above as it is a way how to get around paying workers less during the times of recession.</p>
<p>Nonetheless, the wages will eventually keep up with inflation. Once the reason for low wages dissipated then people on labor markets will bid up nominal wages (and governments will over time raise minimum wages and unions renegotiate industry wages etc), to catch up with inflation.</p>
<p>Nonetheless, inflation might still sound bad as it definitely hurts workers during those periods when real wages decline, but ultimately even for workers its better to have their real wages to drop from time to time than live in an economy with massive  unemployment during recessions like during the Great Depression.</p>
<p>Of course, economics is a science so ultimately there is nothing in economics that says that inflation and low unemployment is better than deflation and high unemployment but I believe virtually everyone would prefer inflation and lower real wages to loosing job if given choice.</p>

CC BY-SA 4.0
2022-11-23T14:23:52.037Z
Thanks a lot! I am going through your input at the moment and I'm stuck at "However, for healthy economy it is necessary that real wages sometimes decline". Why do you bring up especially this example? Why is it necessary that specifically these wages do not go up?
Ben
CC BY-SA 4.0
2022-11-23T14:43:06.190Z
@Ben real wages are just inflation adjusted wages. The reason for that is that in order for labor markets to clear (i.e. not having unnecessary/unnatural unemployment) real (i.e. inflation adjusted) wages have to correspond to the value of marginal product of a workers. If you create 100k value for a company per year it is not sustainable for the company to pay you 200k per year. The problem is that value of your output will vary. In expansion there might be high demand for some labor so value of its product might be high but in recession the value of product of that labor might plummet
1muflon1
CC BY-SA 4.0
2022-11-23T14:46:06.293Z
at that point either the wage is lowered to make sure its not larger than the value of worker's output or the worker will be laid off. Now unemployment is necessarily not bad for an economy, in fact some unemployment - natural unemployment is beneficial - people might wanna switch jobs or wait for better job, but the problem here is that in absence of minimum wage or union contracts both worker and employer might be happy to agree on lower nominal wage because the worker might be happy with lower wage and keeping job. Problem is that they are either forbidden from it from law or renegotiation
1muflon1
CC BY-SA 4.0
2022-11-23T14:46:27.983Z
might be too costly. Inflation solves this issue as described above.
1muflon1
CC BY-SA 4.0
2022-11-23T13:39:05.350Z
2022-11-23T14:01:40.400Z
2022-11-23T14:01:40.400Z
1muflon1
<p>As a follow up on <a href="https://money.stackexchange.com/questions/153726/how-inflation-really-works">How inflation really works?</a> I wonder: Why is inflation or deflation &quot;necessary&quot;? And why is the one better than the other (is it?)?</p>
<p>Can't we raise wages (and the like, whatever this would be) to eliminate inflation? If not, then the working people will simply loose salary more and more over time, right?</p>

CC BY-SA 4.0
2022-11-23T10:42:40.180Z
Tbh, Idk, I understand almost nothing money.. so far, I thought inflation means that there is more money available (whyever) and thus, prices have to go up (whyever). Is this somehow true? But in any case, you raised a(nother?) interesting question ;)
Ben
CC BY-SA 4.0
2022-11-23T11:07:58.860Z
Ok,thanks, then I guess, I would like to address your question indeed: Why do prices go up resp. why do they not go down? I guess wages can hardly go down because you would loose the workers then but are wages special or different compared to other costs?
Ben
CC BY-SA 4.0
2022-11-23T13:14:59.807Z
rising wages **is not inflation** rising wages can **cause inflation**, but inflation is positive change in CPI, CPI does not include wages
1muflon1
CC BY-SA 4.0
2022-11-23T13:17:35.873Z
CPI stands for Consumer price index?
Ben
<inflation><deflation>
Why is there inflation?
Ben
# Why is there inflation?

(Asked by: username_0 on 2022-11-23)

As a follow up on [How inflation really works?](https://money.stackexchange.com/questions/153726/how-inflation-really-works) I wonder: Why is inflation or deflation "necessary"? And why is the one better than the other (is it?)?

Can't we raise wages (and the like, whatever this would be) to eliminate inflation? If not, then the working people will simply loose salary more and more over time, right?

**Tags:** inflation, deflation

> **Comments:**
> **username_0**: Tbh, Idk, I understand almost nothing money.. so far, I thought inflation means that there is more money available (whyever) and thus, prices have to go up (whyever). Is this somehow true? But in any case, you raised a(nother?) interesting question ;)  
> **username_0**: Ok,thanks, then I guess, I would like to address your question indeed: Why do prices go up resp. why do they not go down? I guess wages can hardly go down because you would loose the workers then but are wages special or different compared to other costs?  
> **username_1**: rising wages **is not inflation** rising wages can **cause inflation**, but inflation is positive change in CPI, CPI does not include wages  
> **username_0**: CPI stands for Consumer price index?  

---

## 1 answers

### Answer by username_1 on 2022-11-23. Score: 1

> I wonder: Why is inflation or deflation "necessary"?

Theoretically speaking its not necessary. Theoretically central bank could just follow monetary policy rule that would keep inflation 0 at all times.

Practically however this would be extremely difficult since in real life managing inflation is difficult task. Let me give you analogy; theoretically it would be possible for you to always keep weight 80kg if you manage your calorie intake with infinite precision, but in real life you would most likely not be able to do that and your weight would sometimes over and sometimes under shoot.

The job of central bank is even more difficult. At present we are unable to generate data in real time. Most macroeconomic data that central bank needs are generated with lag (e.g. unemployment, GDP, inflation expectations etc). What even worse, even when data on GDP etc are published they are often being revised. For example, it might take up to 5 years and several rounds of revisions for us to discover what the 'correct' GDP for last quarter of 2021 was, and I am putting the word correct in scare quotes because even the final revision for GDP will have some measurement error.

As a consequence I do not believe any central bank can practically always deliver 0 inflation. They could do that on average in long term but not every single quarter forever.

However, having zero inflation is not necessarily desirable.

> And why is the one better than the other (is it?)?

Because prices and wages are rigid (sticky) for various reasons. There are numerous reasons for wage and price stickiness for complete overview you can have a look at some textbook such as Mankiw Macroeconomics or Blanchard et all macroeconomics. Two important reasons worth while mentioning are minimum wage laws, or union industry-wide wage setting through bargaining (like in Germany).

These create wage rigidities because they usually specify so fixed minimum wage for everyone or for some industry. However, for healthy economy it is necessary that *real* wages sometimes decline (e.g. when there are negative productivity shocks like during major recessions etc).

When inflation is equal to 0 real wage decline requires that countries either lower their minimum wages or unions negotiate lower wages. This is extremely difficult and painstaking process.

Inflation solves this issue since despite minimum wages or union negotiated contracts stay exactly as they were previously, higher inflation means that real value of those wages drops even though employees still get paid same amount of money. This helps to prevent deep recessions with high level of unemployment (such as Great Depression that was caused precisely because of deflation/lack of inflation see discussion in Monetary History of the US by Friedman and Schwartz).

Hence moderate level of inflation (most economists believe its about 2% on average over the course of business cycle and only very few economists would say its outside 0.5-4% range) can be viewed as a grease that helps the cogs of economy turn. On other hand deflation makes sticky wages problem worse as deflation increases real wages. This can be extremely damaging during the times of recession, in fact this is what made depression of 1929 into Great Depression. So deflation can be viewed as a sandpaper that would clog the gears of an economy.

> Can't we raise wages (and the like, whatever this would be) to eliminate inflation

No. Inflation is *by definition* change in consumer price level. To eliminate inflation you have to stop consumer goods from increasing in price.

I know of no economic theory where increase in wages would somehow reduce price of goods and services. In fact exactly the opposite. Raise in wages will likely lead to more inflation because higher wages mean goods are more expensive to produce so stores have to charge higher prices to pay for higher wages.

> If not, then the working people will simply loose salary more and more over time, right?

They do not loose salary, their salary will loose purchasing power over time. Those are not the same things even though their practical welfare effect might be the same.

However, aside the above mentioned technicality, yes inflation continuously erodes real wages of workers. This is not a bug, its a feature as mentioned above as it is a way how to get around paying workers less during the times of recession.

Nonetheless, the wages will eventually keep up with inflation. Once the reason for low wages dissipated then people on labor markets will bid up nominal wages (and governments will over time raise minimum wages and unions renegotiate industry wages etc), to catch up with inflation.

Nonetheless, inflation might still sound bad as it definitely hurts workers during those periods when real wages decline, but ultimately even for workers its better to have their real wages to drop from time to time than live in an economy with massive unemployment during recessions like during the Great Depression.

Of course, economics is a science so ultimately there is nothing in economics that says that inflation and low unemployment is better than deflation and high unemployment but I believe virtually everyone would prefer inflation and lower real wages to loosing job if given choice.

> **Comments:**
> **username_0**: Thanks a lot! I am going through your input at the moment and I'm stuck at "However, for healthy economy it is necessary that real wages sometimes decline". Why do you bring up especially this example? Why is it necessary that specifically these wages do not go up?  
> **username_1**: @username_0 real wages are just inflation adjusted wages. The reason for that is that in order for labor markets to clear (i.e. not having unnecessary/unnatural unemployment) real (i.e. inflation adjusted) wages have to correspond to the value of marginal product of a workers. If you create 100k value for a company per year it is not sustainable for the company to pay you 200k per year. The problem is that value of your output will vary. In expansion there might be high demand for some labor so value of its product might be high but in recession the value of product of that labor might plummet  
> **username_1**: at that point either the wage is lowered to make sure its not larger than the value of worker's output or the worker will be laid off. Now unemployment is necessarily not bad for an economy, in fact some unemployment - natural unemployment is beneficial - people might wanna switch jobs or wait for better job, but the problem here is that in absence of minimum wage or union contracts both worker and employer might be happy to agree on lower nominal wage because the worker might be happy with lower wage and keeping job. Problem is that they are either forbidden from it from law or renegotiation  
> **username_1**: might be too costly. Inflation solves this issue as described above.  

---

