Inflation is the continued growth of prices in an economy over an extended period. It can be seen as a sign of economic growth, as with increases in purchasing power and demand, the inadequacies in supply can lead to increased costs. Burton, Deciba, and Brown also note that the alternative to inflation, deflation, is highly damaging and has the potential to create bankruptcies and defaults. The process benefits customers, as well, by reducing the value of their debts, though this effect affects banks negatively. Lastly, moderate inflation rates can allow prices and wages to adjust and attain their actual value.
With that said, inflation can also have significant adverse effects, mainly when it is high and out of control. It affects all varieties of static monetary assets, and thus, people’s savings are harmed in the process. When inflation is significantly higher without corresponding wage growth, salaries effectively diminish over time. The lowered strength of the currency against those of other nations leads to reduced exports and a worse payment account balance. In extreme cases, inflation can enter self-perpetuating cycles and increase at extremely high rates, effectively destroying the monetary system. The phenomenon is known as hyperinflation, and there are examples of it in the modern world that demonstrate the devastating effects of such an event.
Overall, a small degree of inflation is unavoidable in a healthy economy, but it should also not be allowed to escalate. As a result, most governments in developed countries, represented by the Fed in the United States, try to maintain inflation at a rate of approximately 2%. Past economic research has shown that this figure achieves a balance between benefits and disadvantages. They do so by attempting to control the economy through a variety of monetary policy mechanisms, though various Fed boards have put forward different approaches in the past.