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Moderate Inflation

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Moderate Inflation

Is it possible for inflation to actually be a good thing? It's known that when people hear the word inflation, they might get a bit apprehensive. After all, inflation decreases the value of money and makes prices go higher so why would anyone like it? Well, as it turns out, inflation can actually be beneficial to society! To learn about the benefits of moderate inflation, effects, the relevance of it, and more, keep reading on!

Moderate Inflation Definition

Moderate inflation, also called mild or creeping inflation, is when prices climb steadily over a certain time at a slow rate. It raises consumer expectations that the prices of goods and services will continue to rise, which ends up boosting demand. Consumers will make immediate purchases to avoid the increased future prices. Moderate inflation fosters economic growth in this way.

Moderate inflation is when prices climb steadily (up to 3%) over a certain period of time (usually a year)

Types of Inflation

There are four main types of inflation that usually get the most attention. These are:

  • Moderate inflation (aka Mild inflation, Creeping inflation) - this is a case in which a country's inflation rises slowly but steadily over time, with the effect of inflation being apparent only after a lengthy period of time. Inflation does not go higher than 3% in the course of a year.
  • Walking inflation - This happens when costs grow gradually and the yearly inflation rate is in the single digits. The pace of price growth is usually between 3 and 10 percent.
  • Galloping inflation - This is when an economy's prices are rising at a fast pace and usually reach an inflation rate of over 10% within one year. It is frequently a precursor to hyperinflation.
  • Hyperinflation - This is when an economy sees quick, extreme, and out-of-control price rises. This inflation causes inflation rates that often exceed 50% per month.

Explore more about inflation in our articles:

- Costs of Inflation

- Hyperinflation

- Disinflation

Figure 1 below shows different types of inflation and the corresponding changes in price levels that would occur over time.

moderate inflation types inflation studysmarterFigure 1. Types of inflation, StudySmarter Originals

As a rule, economists don't believe that moderate inflation needs to be reduced. Since the inflation rate rises at such a slow and steady pace over the years, it actually ends up doing more good than harm!

Benefits of Moderate Inflation

There are several benefits to moderate inflation.

For example, in the case that there is underutilized labor or supplies, inflation can potentially assist in improving output. How so? Well, when inflation takes place, more money is needed to buy the same things. The more money that is needed means that people will expect more increases in prices so they want to spend more in case prices go up again, and this in turn creates greater demand. More demand, in turn, leads to more production to supply that need.

Moderate inflation also allows prices to adapt and for products and services to reach their true value. Why is this good? Well, prices will get updated to more accurately reflect what's needed to cover running costs and allow profit at the same time, which is good for those who are selling products and services. Also, employers will increase the salaries and wages of those working for them so as to keep up with the moderate inflation rate, and this benefits the employees.

Inflation rates that are moderate are indicative of a thriving economy. As long as inflation is going up at a moderate pace and wages are also increasing in order to keep up with the inflation, then moderate inflation is a sign of a successful society that is regularly adjusting its economic policies to satisfy the needs of its residents.

Moderate inflation vs deflation

Also, all things considered, moderate inflation is better for the economy than the opposite - deflation. Deflation is defined as a broad decrease in the price of products and services.

People are hesitant to spend money while prices are decreasing because they believe those products and services will cost less in the future. As a result, they continue to sit on their money and wait for things to get cheaper. Furthermore, deflation raises the real worth of debt and diminishes the disposable income of people who are trying to repay loans and get rid of their debt. When people take on a debt, they normally expect a bit of an inflation rate to help diminish the value of the debt over time. If this inflation rate isn't present, then their debt will be greater than they thought it was going to be when they took on the debt.

Deflation is defined as a broad decrease in the price of products and services.

Moderate Inflation Example

Let's take a look at an example of moderate inflation in the United States.

Year Inflation Rate (%)
20150.12%
20161.26%
20172.13%
20182.44%

Table 1: U.S. Interest Rates 2015-2018 - StudySmarter. Source: WorldBank1

As seen in Table 1 above, the inflation rate from 2015 to 2018 rose steadily. From 2015 to 2016, the inflation rate rose by 1.14%; from 2016 to 2017 it rose by 0.87%; from 2017 to 2018 it rose by 0.31%. Several years in a row, the inflation rate rose steadily and never went over 3% in a year. This is a perfect example of moderate inflation. By rising just a bit every year, it's easier to pinpoint by how much it will raise next year and it keeps the economy thriving.

Causes of Inflation

There are typically three main causes of inflation.

These are known as:

  • demand-pull
  • cost-push
  • built-in

Demand-pull

Demand-pull inflation happens when a rise in the availability of money causes an economy's total demand for products and services to rise faster than the capacity of production within the economy. Since people have more access to money, they spend more, and consequently the prices go up. Basically, it creates a high demand with less supply which causes the prices to rise.

Demand-pull inflation is when the demand for products and services within an economy is rising faster than the ability to produce them.

Cost-push

Cost-push inflation is inflation triggered by increases in the pricing of things like labor, resources, and so on. The higher cost of labor, land, and other factors of production reduces the supply of these items. While demand remains steady, commodity costs rise, leading the overall cost level to rise. Numerous circumstances such as natural catastrophes or resource depletion, change in currency rates, and so on might all contribute to cost-push inflation.

Cost-push inflation is when prices rise owing to greater manufacturing costs and higher resource costs

Built-in

Built-in inflation is linked to expectations of inflation, or the belief that present inflation rates will persist in the foreseeable future. Workers and non-workers alike learn to assume that if the price of products and services increases, they will keep climbing at a similar rate in the future and therefore they demand higher salaries to maintain their quality of living.

Built-in inflation is when employees seek greater pay in order to keep pace with growing living expenditures. This drives firms to boost their prices to cover growing wage expenses, creating a self-perpetuating cycle of price and salary raises.

Effects of Moderate Inflation

Let's go over some of the effects of moderate inflation:

Stability

With moderate inflation, the rate of future inflation is usually known because they're compared to the trend of inflation rate rises over the years. With this knowledge, companies can forecast future expenses and consumers can forecast future pricing.

Pay cuts

In the case of moderate inflation, it can be good if the salaries rise along with the rate of inflation. However, if the wages don't increase at the same time, employees are actually working the same job for less pay. In this way, employers can actually reduce the amount they pay less efficient workers just by not increasing their salaries to match the rate of inflation.

Falling value of debt

Moderate inflation diminishes the real cost of debt. Inflation, by definition, makes the price of money fall over time. Essentially, money today is more valuable than money tomorrow. As a result of moderate inflation, debtors might repay lenders with money that is valued less than it was at the time that they borrowed the money.

Relevance of Moderate Inflation

The relevance of moderate inflation is clear. Moderate levels of inflation are often regarded as indications of a strong economy. How so? Well, when the economic growth rises, so does the demand for goods. This rise in demand raises prices a bit as manufacturers strive to produce more of that which is in demand. Employees profit because economic booms increase demand for work, and consequently salaries rise with the demands for work. Ultimately, these higher-paid workers go around and purchase more goods, and this keeps going around and around in a circle.

However, when inflation rates get to be too low or high, this can be dangerous for the economy.

Low inflation typically indicates that demand for products and services has become lower than it ought to be, which slows economic growth and lowers wages. This lack of demand may even result in a recession with increased unemployment.

However, excessive inflation can bring about similar issues. If left uncontrolled, inflation might skyrocket, causing the economy to stagnate swiftly and unemployment to rise. Rising inflation and unemployment are known as stagflation. It may be a challenge for governments to solve stagflation because most activities aimed at lowering inflation might very well increase unemployment, while measures aimed at lowering unemployment might aggravate inflation.

Moderate Inflation - Key Takeaways

  • Moderate inflation is when prices climb steadily (up to 3%) over a year
  • Demand-pull, cost-push, and built-in are the causes of inflation
  • Moderate inflation is better for the economy than the opposite - deflation
  • Rising inflation and unemployment are known as stagflation
  • Moderate levels of inflation are often regarded as indications of a strong economy

References

  1. World Bank, Real Interest Rate United States, 2020

Frequently Asked Questions about Moderate Inflation

Moderate inflation is inflation where prices climb steadily (up to 3%) over a certain period of time (usually a year).

Inflation can potentially assist improve output; it allows prices to adapt and for products/services to reach their true value; it's better than deflation!

The effects are stability, pay cuts, and falling value of debt.

It's good for the economy because when the economic growth rises, so does the demand for goods. This rise in demand raises prices a bit as manufacturers strive to produce more of that which is in demand.  Employees profit because economic booms increase demand for work, and consequently salaries rise with the demands for work. Ultimately, these higher-paid workers go around and purchase more goods, and this keeps going around and around in a circle.

As a rule, economists don't believe that moderate inflation needs to be reduced. Since the inflation rate rises at such a slow and steady pace over the years, it actually ends up doing more good than harm.

Final Moderate Inflation Quiz

Question

What's moderate inflation?

Show answer

Answer

Moderate inflation is when prices climb steadily (up to 3%) over a certain period of time (usually a year).

Show question

Question

By what other names is moderate inflation known as?

Show answer

Answer

Mild inflation; creeping inflation

Show question

Question

What are the four main types of inflation?

Show answer

Answer

Moderate, walking, galloping, hyperinflation

Show question

Question

What's hyperinflation?

Show answer

Answer

This is when an economy sees quick, extreme, and out-of-control price rises. This  inflation causes inflation rates that often exceed 50% per month.

Show question

Question

Galloping inflation is usually a precursor to _______.

Show answer

Answer

hyperinflation 

Show question

Question

What are the three main causes of inflation? 

Show answer

Answer

Demand-pull, cost-push, built-in

Show question

Question

What's built-in inflation?

Show answer

Answer

Built-in inflation is when employees seek greater pay in order to keep pace with growing living expenditures. This drives firms to boost their prices to cover growing wage expenses, creating a self-perpetuating cycle of price and salary raises.

Show question

Question

What are the effects of moderate inflation?

Show answer

Answer

Stability, pay cuts, and falling value of debt.

Show question

Question

What's deflation?

Show answer

Answer

Deflation is defined as a broad decrease in the price of products and services.

Show question

Question

Why is deflation worse than moderate inflation?

Show answer

Answer

Deflation raises the real worth of debt and diminishes the disposable income of people who are trying to repay loans and get rid of their debt. When people take on a debt, they normally expect a bit of an inflation rate (like moderate inflation would provide) to help diminish the value of the debt over time. If this inflation rate isn't present, then their debt will be greater than they thought it was going to be when they took on the debt.

Show question

Question

What's demand-pull inflation?

Show answer

Answer

Demand-pull inflation is when the demand for products and services within an economy are rising faster than the ability to produce them.

Show question

Question

What's cost-push inflation?

Show answer

Answer

Cost-push inflation is when prices rise owing to greater manufacturing costs and higher resource costs.

Show question

Question

Should moderate inflation be reduced?

Show answer

Answer

As a rule, economists don't believe that moderate inflation needs to be reduced. Since the inflation rate rises at such a slow and steady pace over the years, it actually ends up doing more good than harm.

Show question

Question

Walking inflation keeps inflation rates between _ and __ percent.

Show answer

Answer

3 and 10

Show question

Question

Inflation rates that are moderate are indicative of a ______ economy.

Show answer

Answer

thriving

Show question

Question

When prices climb steadily over a certain time at a slow rate:

Show answer

Answer

Moderate inflation

Show question

Question

Moderate inflation ______ economic growth.


Show answer

Answer

fosters

Show question

Question

When the pace of price growth is usually between 3 and 10 percent:

Show answer

Answer

walking inflation

Show question

Question

This occurs when an economy's prices are rising at a fast pace and usually reach an inflation rate of over 10% within one year. 


Show answer

Answer

galloping inflation

Show question

Question

This occurs when an economy sees quick, extreme, and out-of-control price rises.

Show answer

Answer

hyperinflation

Show question

Question

Deflation occurs when:

Show answer

Answer

there is a decrease in prices

Show question

Question

True or False: Inflation rates that are moderate are indicative of a thriving economy. 

Show answer

Answer

True

Show question

Question

Generally, economists believe that moderate inflation:

Show answer

Answer

should not be reduced

Show question

Question

Deflation will cause consumers to:

Show answer

Answer

sit on money instead of spending it

Show question

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Deflation will cause real debt to:

Show answer

Answer

increase

Show question

Question

Which of the following is NOT a cause of inflation?

Show answer

Answer

none of the above

Show question

Question

Demand-pull inflation happens when: =


Show answer

Answer

a rise in the availability of money causes an economy's total demand for products and services to rise faster than the capacity of production within the economy

Show question

Question

Cost-push inflation is: when prices rise owing to greater manufacturing costs and higher resource costs


Show answer

Answer

when prices rise owing to greater manufacturing costs and higher resource costs

Show question

Question

Built-in inflation is: 


Show answer

Answer

when employees seek greater pay in order to keep pace with growing living expenditures.

Show question

Question

Moderate inflation is when prices rise about:

Show answer

Answer

3% per year

Show question

Question

True or False: moderate inflation is better for the economy than deflation.

Show answer

Answer

True

Show question

Question

True or False: Rising inflation and unemployment are known as stagflation

Show answer

Answer

True

Show question

Question

True or False: Moderate levels of inflation are often regarded as indications of a strong economy

Show answer

Answer

True

Show question

Question

True or False: Hyperinflation is similar to moderate inflation.

Show answer

Answer

False

Show question

Question

True or False: Moderate inflation is unpopular with the government.

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Answer

False

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