The inflation and the growth

The Bank of Japan keeps its monetary policy on hold to keep inflation moving toward the 2.0% target. The Bank of England also sets its inflation target at 2.0%, and other central banks also have similar targets. Previously I have explained why inflation is important for governments, today I want to discuss how inflation relates to economic growth.

Inflation usually implies an increase in the prices in the domestic markets on average; however, when a country actually measures its domestic inflation, it only measures the change in the average prices of a basket of several selected goods and services, as it is impossible to measure all price changes all cross the economy. Therefore, sometimes some price decreases are not observed in our inflation sample.

Growth does not necessarily lead to an inflation; however, sometimes an inflation can lead to an economic growth. Inflation can redistribute the resources in the economy. Inflation signals price increases in some sectors of the economy. Once price increases usually imply increases in demand, so the market is likely to react to the increases in demand and increase the supply. Such process can help to improve the efficiency of the resource distribution. Once the resources are distributed more efficiently, the economy will grow.

I explained the reason for why an economic growth does not necessarily lead to an inflation previously, so I will only give a simple example to explain this question again. We usually think the price for smart phones has a slowly increasing trend; however, that is not true. Apple’s iPhone is a famous smartphone, once the new version of iPhone usually has a slightly higher price than its previous version. However, when we look at the inflation, we do not see this as a price increase. Once the new version is released, the price of the older version decreases, so it is a price decrease (deflation).

Overall, I believe, inflation causes an economic inflation as inflation implies a shortage of supply in the economy that pushes the supply as well as the production in the economy, thus leading to an economic growth.