Thursday 2 December 2010
What is the targetted 2% inflation rate going to do to your purchasing power?
So why is 2% per year the "targetted rate" of the Central Banks? The short and sweet answer is that it'll quite quickly be eaten away, as the numbers above demonstrate. Fast enough you are encouraged not to hoard your cash in the bank, but will circulate it back out into the economy by "buying stuff" from others working in the economy alongside you. So you all will keep each other busy and in paying jobs. Not so fast that everyone might think "I must dump this money fast because it will be worthless by next year", but at the same time the average person should be able to subconsciously realise that keeping the cash forever is not the best use of it.
I have used euros for the denomination above, because the ECB only has a mandate to achieve 2% (or slightly below) inflation over a medium term horizon. In the Eurozone, they've done a pretty good job of maintaining 1.9% average inflation since the inception of the euro. In the UK in the course of the last few years we have seen CPI inflation anything from below 0% (deflation) to over 3%. This is why we have had an unstable business environment in the UK while economic activity has pretty much remained stable in the core Eurozone economies. This is why more and more countries are looking at the euro and thinking they'd like to be a part of it, most recently Russia.
The euro is the antidote to the natural fiscal problems that are a consequence of Democracy in combination with a locally-controlled paper currency. The politicians in the Eurozone can and will point at the euro as the reason they can no longer use public sector debt to satisfy voter's desires for something-for-nothing-today that will be paid for by someone-else-tomorrow. In the long term, that is a good thing in my opinion. Voters don't understand what they have been asking the politicians to do, it is not in their own best long term interests to continue borrowing from their own future. Look at the world today — we have reached "yesterday's" "tomorrow". In Europe this is being faced up to and dealt with. Elsewhere the attempts are to once again defer today's and yesterday's costs until yet another tomorrow, when it will cost even more still than it would today. Some day, yesterday simply must be paid for by someone today.