Why central banks love inflation

It is often thought that inflation is the enemy of those trying to run the economy. But in fact, central banks these days need to keep inflation going at all costs to prop up our increasingly fragile economic system, says Richard Benson of Specialty Finance Group. And that means that the current US economic model has more in common with a banana republic than the Federal Reserve would like us to believe...

Orthodox economic training in the United States in the post-World War II world, centred on the observations of John M. Keynes who claimed that to keep an economy rolling, spending (aggregate demand) needed to be kept alive at all costs. The biggest post-depression fear was that saving too much could cause spending to fall short and recession, or worse, could befall the economy (from 1929 to World War II, the worse did happen).

The Keynesian trick used by the US central bank was to cut interest rates to a level low enough to encourage businesses to spend excess savings. Low interest rates encourage low financing costs and urge businesses to recycle savings into productive investment, which keeps the economy humming especially if consumer spending is weak.

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