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Why Some Governments Like Inflation

Sam Vaknin, Ph.D. - 7/28/2008

Some governments like and encourage inflation because inflation masks the true situation and makes them look good. Inflation helps to deceive the public and even experienced observers. How?

1. As the general price level increases (in other words, as the prices of virtually everything go up), companies derive more income from the sales of the same goods and services. Consequently, of course, they pay more taxes. This allows the government to spend more: to raise salaries, construct sports halls, and generally make the population at large feel better. Without inflation, the state budget would have been in deficit, not in surplus.

2. Inflation means that the value of the currency goes down. The Macedonian denar is worth less at the end of the year than it did at its beginning. Thus, when the government pays suppliers, or returns its debts, it does so with a depreciated currency. It borrows when the denar is strong and pays out when it is weak. Inflation acts, therefore, like a kind of tax on the economy.

3. As inflation sets in, people are afraid that prices will continue to go up. So, they stop saving money and instead spend it and consume in order to "lock down" the current prices, before they increase again. This creates an artificial and short-term boom. GDP grows as consumption soars. It is bad for investments, though: people stop saving or withdraw their existing savings and the banks have no money to lend to businesses. But, who cares? The effects of this irresponsible and destructive economic policy will be felt only after the next elections. And, in the meantime, carpe diem.