Why Inflation is Necessary: Understanding Its Importance for the Economy?

• Many countries have witnessed an increase in inflation rates due to multiple factors such as economic stimulus packages and the Russian Ukrainian war.
• Central banks around the world have raised interest rates to combat inflation, specifically in the first quarter of 2022.
• Despite the negative effects of inflation, it may have certain benefits in some cases, such as stimulating consumption and economic growth.
• Some indicators indicate that inflation falling below target rates may reflect the risk of economic recession.

Introduction:

Over the past two years, inflation has been the hero of the economic scene, overshadowing various other economic indicators and data, across economies around the world, as various countries sought to reduce inflation to the required levels according to the monetary and fiscal policy of each country.

However, the European Central Bank was not comfortable when inflation fell below its target level, which indicates that inflation at certain levels will be a necessary requirement. Here, we will try to answer the main question: Why Inflation is Necessary?

Since the end of 2021, global economies have been on a date with inflation rates rising to record historical levels, which were the highest in four decades, specifically on the American side.

The concept of inflation and its causes:

The term inflation refers to the rise in price levels in general, or the decline in the purchasing value of a country's currency for various reasons, whether related to a decrease in supply or an increase in demand.

The trillion-dollar stimulus packages were behind the rise in inflation, when various countries pumped trillions of dollars to stimulate their economies in 2020 and prevent them from slipping into recession because of the general closure that the world was exposed to due to the health pandemic at the time.

The Russian Ukrainian war in 2022 was an additional reason that raised prices because of the trade disruptions that affected many goods that were passing through the Black Sea and other trade routes near conflict zones.

Thus, the demand factor (the increase in purchasing power of individuals bdoublethe stimulus package) combined with the supply factor (the decrease in the supply of basic goods and products), to raise the inflation rate and knock on the door of the double-digit percentages in important economies such as the European Union.

Should inflation end completely?

Various central banks rushed to raise interest rates, as a traditional means of combating inflation, so that interest rates reached their highest levels almost since the global financial crisis, with many central banks succeeding in reducing inflation to low levels.

However, during the fourth quarter of 2024, the European Central Bank succeeded in reducing inflation to levels below the target rate (2%), when it recorded levels of 1.7%, which prompted analysts to expect the European economy to be dragged into a type of economic recession, which led to the question of why low inflation is linked to the possibility of economic recession, which will be answered by explaining the reasons for the need for inflation in the first place.

Why Inflation is Necessary?

Despite the negative view that has been spread about inflation in the past few years, inflation can also be viewed positively.

While consumers do not want inflation to rise, because it will consume a large part of their income and savings, owners of tangible assets, such as property or stored goods, will want to see some inflation, because it increases the value of their assets.

There are even those who believe that inflation at studied levels will enhance the principle of spending money to a certain extent instead of saving it, to benefit as much as possible from the current purchasing power, which is considered a booster of economic growth.

As for the optimal rate of inflation, it varies from one country to another. While a country may set inflation at a specific rate, some countries set inflation within a percentage range.

It can be noted that countries such as the United States of America, Europe, Britain, Canada, and Sweden have set the inflation rate at the required levels of 2%, while a country such as Switzerland has set its inflation rate at a range between 0-2%.

As for the 2% levels, some studies have indicated that if inflation rises above 2%, it will cause the state's ability to control the economy and price levels to decline.

While some other studies have indicated that inflation rising above 2% will make the state more vulnerable to economic problems.

However, if inflation falls below the required rate, as happened with the European side before its inflation returned to exceeding 2% at the end of 2024, some analysts have indicated that it is a warning sign that the economy may be on its way to recession or contraction, for many reasons, most notably:

• Low inflation (low prices) may express a decrease in consumption in general, and that producers and sellers are now forced to reduce prices to keep up with the decrease in prices.
• Low inflation may give a negative impression to foreign investments in that economy, which creates a repellent investment environment.
• Low prices may discourage production due to low profitability, and thus economic contraction occurs gradually.

Conclusion:

The issue of inflation is central to the global economy, as countries have sought to reduce it through monetary policies, as since 2021, the world has witnessed a rise in inflation due to stimulus packages after Corona and the Russian Ukrainian war, which led to raising interest rates as a traditional means of combating inflation.

Although inflation is considered negative, some of it may be useful in stimulating consumption and economic growth, while its decline from target rates indicates the risk of economic recession.