Why Does the U.S. Want Inflation So Bad?

Lauren Reiff
Sep 5 · 8 min read
Photo by Jp Valery on Unsplash

It’s been lamented by the monetary overlords for years: Inflation never shows up. It is stubbornly evasive, not to mention resistant to the strategic efforts to bring it out of hiding. This is a vexing problem, apparently. Fed officials are genuinely perplexed by this seemingly irrational reality.

Interest rates, by most historical measures, have been quite suppressed — what is a generally accepted precursor to inflation. And yet this tonic failed to illicit any hint of an inflationary response in the economy. Even the daring experiment of quantitative easing a decade ago proved to be just as startlingly ineffectual.

And yet year after year, those at the helm trumpet their favorite neat and orderly statistic as the point of perfection that inflation should be at. The so-called 2% inflation target — a metric arrived at as the “sweet spot” between too little inflation and too much — is increasingly less deserving of the name “target” (because we rarely manage to reach it) and instead, more of a wishful fantasy.

Now, you might be curious: Why this fixation on a “target” number? What does it mean if we don’t reach it? Or, you might be wondering: Inflation isn’t necessarily good, is it? Well, there’s a number of reasons that governments in general prefer inflation and why monetary policy officials in modern-day America are so laser-focused on producing this metric.

Also of consequence is why, despite the repeated attempts to cajole inflation out of the woodwork, we just don’t really have it. The answers to these important questions reveal both the true colors of government in addition to the interesting forces currently at play that prevent inflation from actually showing up and making its presence known.

Why does the government like inflation?

When it comes to the opposing forces of inflation and deflation, governments far prefer inflation. It’s unquestionably the more politically favorable of the two. Part of the logic is that, at the very least, inflation greases the wheels of the economy and keeps things running. Deflation certainly doesn’t do that — it tends to grind things to a halt and this is usually regarded as a fearsome threat.

Inflation, on the other hand, stimulates the economy, loosing money from people’s hands. Why is this? Because they’ve been goaded into believing it is advantageous to spend now rather than later. Inflation imposes a sense or urgency and prioritizes the present over the future.

Naturally, this makes everything look better and bigger and brighter. GDP figures tend to rise, businesses tend to receive an uptick in sales, and people are more carefree in marching to the bank and snapping up a loan.

Thus, it’s not hard to see the “cosmetic” benefits to inflation — why governments like it for the happy gloss that it tends to give an economy. In such an environment, individuals tend to have less bitter feelings towards monetary figures and less criticisms to air. Instead, they are grateful for an economically comfortable environment — regardless of how exactly it was orchestrated or whether it’s really working for the everyday American.

This said, there is a fine line between the kind of inflation that governments are after — moderately-paced, steady, almost undetectable — and inflation that has gotten out of hand. History has more than a few examples of this.

Runaway inflation — otherwise known as hyperinflation — is decidedly not the kind of crazed, uncontrollable environment that the Federal Reserve is after. Central banks and governments alike would prefer that inflation go somewhat undetected — to smoothly introduce itself so that nobody bats an eye and everybody just goes along with it swimmingly.

What is inflation hiding?

There’s a reason that inflation is called a hidden tax. Because it pushes in one direction, it must, by definition, incentivize either buyers or savers — one over the other. In the case of inflation, it demonstrably incentivizes buyers, supplying them with the conditions conducive to their putting their money out into the economy instead of holding on to it.

Of course, one has to ask that if the Fed publicly states that they wish to have 2% inflation indefinitely, whether this does not indicate an equally permanent stand to favor spenders over savers. (Answer: it does.) This is a bit questionable in that it tips the scales unnaturally and unhealthily towards the spendthrift and away from the frugal man. On a long-term basis, this has consequences.

(Of course, the typical retort to criticizing why we even need a steady rate of inflation at all every year is that wages, prices, and living costs tend to rise so the inflation target, in theory, will match these metrics. Needless to say, this kind of seamless cooperation is a rare event. It’s way too much of a “laboratory fantasy”. Thus, one has to question that if 2% inflation, for example, isn’t necessarily warranted, then what are the full range of intentions behind it?)

As it turns out, inflation has a few more tricks up its sleeve. I’ll touch on a few more: Because of its erosion of purchasing power, it is the instrumental ingredient in devaluing the dollar. An ambition to depreciate the domestic currency usually surfaces in order to make exports more competitive in the global marketplace.

In addition, inflation reduces the national debt burden which is an enormous draw for those in government (especially considering the 23 trillion dollars of obligations we currently have).

The Fed needs some wiggle room

There’s also the need for a “buffer” to consider. Fed officials have a tricky hot/cold relationship with low interest rates. As they see it, they are clever devices insofar as they tend to expand the economy, but if they are too low, then they restrict the amount of ammunition the Fed has if the nation wanders into an unexpected crisis.

If a downturn occurs, the Fed usually finds it necessary to lower interest rates to provide liquidity that is presently running dry. If they are already very low, then, in a sense, there is nowhere to go. The Fed has their hands tied.

Consequently, central bankers get queasy when they don’t have this leverage at their disposal. If the U.S. in its current state had more inflation it theoretically would be able to raise rates without causing any issues. But because inflation is weak this method can’t be utilized as much as the Fed would like.

The Fed’s PR Dilemma

On a slightly different note, it appears the Fed is so hell-bent on inflation targeting in part because it has such a flair for metrics. It adores the illusion of control. It adores the illusion of possessing comprehensive knowledge of the economy. Never mind if it’s actually capable of these things, of course.

There is something kind of grandiosely presumptuousness about the idea that inflation targeting is actually achievable, after all. Remember, it’s a modern venture confined only to the past several decades. It exemplifies the rigidly scientific attitude taken by so many ensconced in monetary affairs and government. It’s a risky scientific attitude that can potentially blind observers to the behavioral component of the economy.

In addition, the Fed’s ability to produce inflation when it says it wants to is a crucial PR issue. It’s not so much a superficial concern for the institution’s reputation as it is one of the most formidable determinants to the collective consumer confidence of the entire nation.

Can the Fed actually achieve what it says it will? If not, how does that look to the individual citizen?

The Fed’s inability to reach their targets usually hits a nerve somewhere, regardless if people “consciously” notice this or not. That is to say, the reputation of the Fed affects the inflation expectations of consumers (how optimistic/pessimistic are they about the economy) in addition to shaping their future purchasing decisions.

If the Fed struggles to control the economic seas (when they allegedly proclaim that they can), this is bound to engender some degree of economic skittishness (And it does — which I’ll point out in a little bit).

In short, the central bank needs to keep up appearances but if they are unsuccessful in this, not only might their veneer slip, but the economy will skid too.

So why don’t we have inflation?

Deflationary forces

Now that we’ve laid out the multiplicity of reasons why governments like to get their hands on inflation, there’s another question left to address: Why exactly is inflation so elusive and why is the economic establishment so confused as to its whereabouts?

Turns out, the answer has much to do with uniquely modern phenomenons as it does to a surprisingly overlooked feature of inflationary efforts.

There are two especially rampant effects today that are very good at dampening inflation. The continued rise in globalization accounts for one of these effects. Global competition is deflationary insofar as it tends to put downward pressure on prices which, remember, is the antithesis of inflation-hungry government officials.

The second is technological innovation which tends to slash costs by generally making operations more efficient. These deflationary forces have been in action for decades. And as far as their strength goes, they are indeed, quite strong.

What’s interesting is that we don’t really feel full-on deflationary gusts because all of the efforts to induce inflation have gone towards evening out the aforementioned deflationary effects.

This partly accounts for the mysterious absence of inflation in the wake of low interest rates and a seemingly golden economy. This is why things appear relatively stable — inflation is tepid because it’s being counteracted by natural deflationary forces.

Emotional humans & their uncertainty

There’s a second reason why inflation fails to take effect and it’s of a different breed. It has to do with people’s expectations of the economic future. It’s not so much whether the future will be good or bad that haunts people as much as it is the degree to which the future appears uncertain. This makes people wary and makes them cling on to their money.

Blinded by economic models and Phillips Curves and the like, monetary policymakers just do not consider the “emotional” pulse of the economy. They don’t have a way of measuring at what point people decide they are safe to spend (and maybe better off if they do so).

Ergo, this part of the equation is discarded as flimsy and irrelevant when, in fact, it constitutes the missing puzzle piece as to why inflation doesn’t just move already. The trouble with economists is that what they can’t quantify, they assume doesn’t exist.

Essentially, people aren’t receiving the gut signals they need to produce the kind of consumer spending that the Fed is currently looking for. Mostly because the economic environment just looks too dangerously uncertain! There is a lot of shifting elements and people feel this on an intuitive level. Their uncooperativeness (though understandable and warranted given the assuredly “uncertain economic climate”) does not help to hit that ever-present 2% inflation target.

The government can increase the money supply all they want, but if they can’t unstick citizen sentiment, then it will do hardly a thing. People will drag their feet in engaging in consumer spending and business investment, and the numbers will show this reluctance. The trouble is, economists are too often befuddled by this hidden behavioral component.

The quest for inflation is a decade long and shows no signs of stopping. The U.S. lusts after it not only because it’s politically expedient but also because it gives the Fed something crucial to work with — something to manipulate if the economy goes south. Of course, making good (or not) on stated inflation objectives fulfills the most important duty of all — maintaining confidence (or not).

Inflation’s elusiveness shouldn’t be a mystery. It’s currently fighting a battle with modern deflationary forces and refusing to come fully out of the shadows precisely because people aren’t fully convinced by the calls to spend and borrow. And maybe with good reason.

Hopefully, this article helped some in addressing two central questions. They are: What does the government want with 2% inflation? And, why has it been hiding from us?

Dialogue & Discourse

News and ideas worth talking about. Fundamentally informative and intelligently analytical.

Lauren Reiff

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Dialogue & Discourse

News and ideas worth talking about. Fundamentally informative and intelligently analytical.

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