Why is that not good? When inflation is close to 0 real interest rates increase which causes the economy to slow down. It seems clear to me that the optimal rate of inflation is always above 0.
Why is that not good? When inflation is close to 0 real interest rates increase which causes the economy to slow down. It seems clear to me that the optimal rate of inflation is always above 0.
The real problem imo is that below 0% is really bad, and has the potential to spiral. So the fed does not target anything close to 0%, but instead targets some buffer above it.
So it's not that "2% is good", but more that "2% is the best buffer we've decided above the <0% super scary threshold"
Yes of course below 0% is especially bad, but I dont think thats the whole story. If central banks were able to set inflation with 100% certainty I still think targeting a number close to 0% is a bad idea. Nominal interest rates have a floor due to defaults, servicing costs. As inflation approaches 0 that floor is hit and monetary policy loses its ability to control real interest rates. Keeping nominal rates above their floor is key to ensuring small business can obtain liquidity, as the floor is approached it makes less sense for lenders to write small loans.
There are many other reasons a positive inflation rate is better than substantially near 0. One common complaint about inflation is that erodes real wages because nominal wages are sticky, but this is actually a good thing. It gives businesses room to breathe during downturns without cutting nominal wages or having to cut staff. Positive inflation also forces cash into productive uses which helps monetary policy because it keeps the actaul money supply more stable.
The Fed did a study some time back estimating CPI levels since 1800. [1] They found that from 1800 to 1950 the CPI never shifted more than 25 points from the starting base of 51, so it always stayed within +/- ~50% of that baseline. That's through the Civil War, both World Wars, Spanish Flu, and much more. And obviously the US economy increased in sized quite exponentially from 1800 to 1950, with no persistent inflation whatsoever.
It's even more interesting to contrast this from 1971 onward. 1971 is when Bretton Woods ended and the government was given a free hand to start 'printing money' so to speak, and inflation became the new policy. Since then the CPI has increased by more than 800 points, 1600% more than our baseline. And it's only increasing faster now - to the point that these numbers I'm giving are already rather outdated.
[1] - https://www.minneapolisfed.org/about-us/monetary-policy/infl...
The US economy faced repeated economic catastrophes from 1800-1950 largely because the government was unable to enact monetary policy. The long depression of the 1870s happened pretty much solely because monetary supply contracted and populists got elected to fuck with the silver/gold standard. Causes of the great depression are more varied, but contraction of money supply due is certainly one of the leading ones.
Yes, the economy expanded greatly over this period, but you have to separate inflation from many other causes such as innovation, increasing labor supply, better education, increases in the amount of investment. I think its pretty clear that the economy wouldve fared much better in the 1800-1950 period if the government was partaking in monetary policy that focused on small but positive inflation.