Why don’t governments target zero inflation?

What they're really targeting is not to have negative inflation/deflation. It's traditionally thought that if prices are going down the economy will stagnate as people wait to make purchases later, which results in less output and a recession.

Because reaching a steady level of inflation is hard due to the nature of the markets, economy and the tools available to central banks they aim for 2% so it can wiggle around that - rather than around 0%

It's interesting that more recently economists have started to disagree that a little deflation is a bad thing - for example Switzerland last decade (but Switzerland is a small very stable economy).

https://www.investopedia.com/articles/markets/111715/can-def...

Zero inflation means that a risk-free way to hold on to all of your value forever is by just holding it. Inflation incentivizes people to buy/invest as opposed to just holding onto money.

Holding onto money is bad because every dollar you spend, another man earns. A lack of spending from one party is a lack of earning for another. The economy functions not on people having money, but on people continually spending that money and moving it from one party to another to incentivize work being done and problems being solved.

Governments create inflation by generating (aka 'printing', but nowadays it's ofc all digital) money. The more money they print, the more income is generated to finance government spending.

> Western governments all seem to target 2% annual inflation

2% is seen as a sweet spot: it still allows governments to print extra money but the inflation rate is not so high that it would lead to an inflation spiral that would run out of control.

To encourage growth. If money is continually losing value, you have to continually work harder to outpace the loss. This encourages workers to keep working, and encourages businesses to keep innovating.

I'm not sure I'm cynical enough to say it's the reason, but inflation helps governments by reducing the real size of their enormous debts.

Many people here seem to have rather generous views for governmental motives. I don’t.

Inflation is a hidden tax on the population. Instead of taking the numbers out of their bank accounts or dollars out of their hands, they can just print the money. This erodes purchasing power of individuals but also allows the government to spend more than they could from traditional tax hauls alone. The people think that they’re getting something for nothing, and politicians get re-elected. Additionally, such a scheme allows for the military actions that the USA loves to engage in. Without inflationary spending, the taxation becomes onerous enough that people wouldn’t passively accept it.

The other reason is “growth”. With low interest rates and a decent amount of printing, you get two major effects. First, lenders are more willing to lend because they’re not paying high interest. The price of money is lower, and therefore money is easier to part with. The second reason is a follow on from that, monetary velocity increases. Monetary velocity generally helps your local government as sales taxes get paid.

The problem with low interest and moderate inflation is that the lenders do not scrutinize things very well (because money is cheaper), so you get a lot of investments that don’t play out as a consequence. Likewise, the inflation is typically tied to assets at first (land, equities, metals) but eventually it does hit product prices and this results in moments of severe inflation. This usually occurs when the P/E ratios get bad enough and the equities markets crash. It also creates problems like 2008 given a long enough cycle. Every time these crashes occur, governments usually try to assume more power as they advertise themselves as the saviors for the problems that their own monetary policy created.

Full disclosure, in a philosophical sense I consider myself a bit of an anarchist (just straight black flag, non-aligned), but in a practical sense I consider myself a mildly left but small government person. For example, I would happily trade constant war and standing armies for a public health care option, or even trade the war on drugs for a national rehab service. Due to the realities of finance, however, I do not believe that everything can be had, and giving the most corrupt people in a society (the politicians) unlimited power is Avery bad idea imho.

I'm seeing some rather naïve explanations here like it incentivizes spending and encourages economic growth.

There's absolutely no need to artificially incentivize spending. Humans naturally require and desire goods and services. Allowing people to store their economic energy without risk of devaluation would actually help bring people out of poverty. Inflating the money supply incentivizes high time preference behavior like excessive spending and borrowing. This leads to boom and bust cycles, and an increasingly growing wealth gap.

All inflation does in terms of growth is increase the nominal value of things in the economy. It does not encourage the growth of real wealth. The increase of wealth we experienced is due to the markets functioning despite an inflationary monetary policy and excessive regulation.

The real reason why the government is in favor of a "slightly inflationary" monetary policy is because they're incentivized to do so. They can spend it before price adjustments due to the new inflows of cash can happen in the wider economy. Its essentially a hidden tax. Governments, central banks, and their political/economic allies can benefit from this effect at the expense of everyone else in the economy.

https://en.wikipedia.org/wiki/Richard_Cantillon#Monetary_the...

>Western governments all seem to target 2% annual inflation. Why is this?

When currencies operated via the gold standard. Inflation of gold was out of their control, gold mining, gold rush etc. Which tended to be about 2%. This goes back to antiquity. Roman emperors clipped metal off their coins and thus created inflation. Inflation doesn't exist in economics, inflation is a political tool.

This is it though, that's why it's 2%, nobody has ever had the courage to aim at anything lower.

But now that it's not gold standard, what is the 2%? This is actually government being able to print money for free. 2% of total money supply pays for quite a significant amount of government. This is compounding obviously, so it's not a long term strategy. However, this is what makes large currencies so powerful.

>Why not target 0% to make financial projections simpler for businesses and households?

The government has to raise taxes(not going to work) or reduce spending(very very not going to happen)

So aiming for 0% isn't plausible not because of economics, but because of politicians.

Something did happen in 2020, usa/canada/others no longer targeted 2%. They targeted >10%. The government printed a ton of money to pay for extreme spending. Canada for example put more debt on the books in the last few years than all other prime ministers in history combined; inflation adjusted. Someone will pay for this eventually or retirees are coming back to work.

Something that I don’t think it’s been mentioned is that it gives economic actors some room to adjust prices/wages down in real terms without requiring a nominal decrease.

Inflation makes it less attractive to hold cash - it's worth less year over year. Experience says we want to make hoarding cash less attractive, and investing more attractive, so we want a little inflation.

The size of the economy and the size of the money supply are very hard to measure; the best we can do is estimate. As the economy grows, the amount of money must be allowed to grow as well or we will have deflation. Even a small amount of deflation is widely regarded as worse than a small amount of inflation, so they try to err on on the positive side.

The usual justification is that wages are "sticky" - that people really don't like it when their employer decreases their wage, taking it as a comment on their worth, leading to a bad work environment, etc. So when a business finds that their product isn't selling as well at the moment, they can't easily avoid bankruptcy by just cutting their employees' wages. Similarly, when a worker is becoming less productive with age, cutting their wage to make employing them still profitable is hard to do.

Solution: Just have everyone's real wage go down 2% a year, unless the employer specifically raises the wage to compensate for inflation. Supposedly, people are too dumb to realize that not raising their wage when there is inflation is the same as decreasing their wage when there is no inflation. Maybe they are that dumb - I haven't looked at the data.

There isn't really a strong theoretical reason.

A few I've seen:

(1) it seems to be difficult for central banks to implement negative nominal interest rates (cash can go under the matrress), and so a positive inflation target will allow a government a bit more scope to cut interest rates during a recession without running into a 'zero lower bound'.

(2) 0% nominal pay rises seem to be a focal point in wage negotiations, and so positive inflation will allow nominal wages to fall in a recession.

There are other arguments I have seem, but all seem quite weak. I don't think there is some definitive justification for 2% vs 5% vs. 0% that can be derived from first principals.

Milton Friedman actually pointed out some theoretical benefits of negative inflation [1].

https://en.wikipedia.org/wiki/Friedman_rule

One thing to point out is that we sort of have empirical evidence that this is good.

High (hyper) inflation is very bad, and hard to escape. It can also happen to developed economies. Even if you discard 2022 energy-induced inflation, look at Turkey.

Deflation - less examples, but Japan comes to mind. Deflation is associated with economic stagnation (others are commenting on causation, I'll leave it be).

There's another argument, as to whether we need GDP growth. Japan doesn't have any, and seems like a pleasant place to live, if you're Japanese at least. I'm not convinced, but the basis is, inflation around 2% is seen as a kind of prerequisite to GDP growth, which is assumed be good and necessary.

The economy naturally grows as we have more children. If the money supply is unchanged, this will cause deflation.

Is 2% a good target? Probably not. Probably there should be a better connection to the population growth rate.

Ultimately the goal is price stability.

A simple answer is that it is a highly effective tax. It dilutes our purchasing power and channels the upside of that dilution to those who control the money supply (or those close to those who control it [0], or own dollar denominated debt. I do not think a government would be willing to give up a tax opportunity, especially if it is not politically objectionable.

[0]: https://www.investopedia.com/terms/b/biflation.asp#toc-the-c...

Imagine that you have the power of gov. spending. Would you want that limited or rationalized? The 2% figure is defined by government statisticians. When those figures don't suit their spending desires, they will trot out concepts like "symmetric inflation".

If government statisticians measure inflation to be less than 2% for a period of time, they will claim that inflation above this rate is required to achieve a symmetric rate of 2%. Even if we accept these premises, why then is a lower rate not "symmetrically" targeted when government statisticians measure inflation to be 8%?

The system is better understood as a method of rationalization for gov. spending, political favors and "stimulus".

The question is a good one, but I think you would be better served by questioning some of the underlying premises before proceeding.

Why not allow the market to set interest rates? Why must capital be allocated by government technocrats? How can fallible men with imperfect information determine prices better than decentralized market mechanisms? When in history has price fixing been beneficial? What were the results of emperor Diocletian's edicts on maximum prices?

Also note the shifting definition of inflation itself. Price inflation vs. the original definition, inflation of the money supply.

You want some inflation to allow for economic growth - it discounts prior debt, and encourages investment.

But it must be tied to growth.

The justification given in my macroeconomics class is the government wants money to circulate through the economy (lending and investing, leading to growth) rather than sitting stagnant in someone's savings account.

So they need to make money worth less over time if you just hold onto it.

Here's a great piece explaining how governments benefit from inflation (and an argument why we will see continually high inflation in the coming decade)

https://archive.ph/Y5tvm

Because zero is too close to negative which freaks people out with bad headlines...

As money wears out, gets lost, destroyed stolen, the total supply drops, pushing atomic value higher. It's hard to buy bread when 1 penny buys a Lexus.

Also, the more money you print tomorrow, the less today's debt is worth.

All money is created as debt. With inflation at least we decrease some of that burden over time.

To have a larger amount of money in circulation because of population and wealth growth.

too much inflation people waste too much energy calculating prices. Too little inflation people don’t spend enough time on calculating prices. same with employee churn, up or out policies.

Zero inflation does not line their pockets

“Growth”.

It’s how Consumer Capitalism is thought to work.