This article was originally published by Frank Shostak at The Mises Institute.
According to the Washington Times from June 10, 2026, the US President Donald Trump brushed off the rising inflation number—i.e., the yearly growth rate of the consumer price index (CPI)—which jumped to 4.2 percent in May from 3.8 percent in April.
“No, I love it. The numbers were great. You know what I really love? I love the inflation,” Mr. Trump said in the Oval Office. The US President may be expressing a view that is popular in economics. By this way of thinking, the policy of price stability does not always mean that the central bank must fight inflation. It is also the role of the central bank to prevent large declines in the inflation rate, or an outright decline in the general price level. Why would that be?
The argument is that a decline in the price level, which is labeled deflation, weakens consumer and business expenditure, thereby paralyzing economic activity. Furthermore, a decline in the pace of increases in the prices of goods and services (i.e., declining measured inflation) raises real interest rates, thereby further weakening the economy. Additionally, as expenditure weakens, this further raises unutilized capacity and puts additional downward pressure on the price level.
Most economists are of the view that it is much harder for the central bank to handle deflation than inflation. When inflation rises, the central bank can always “cool it off” by large increases in interest rates. With regard to deflation, the lowest percentage to which the central bank can take its policy rate is zero. Below this percentage, individuals are likely to be reluctant to lend. Now, by popular thinking, the real interest rate is defined as follows:
Real interest rate = Nominal interest rate – Inflation rate
From this one can establish that:
Nominal interest rate = Real interest rate + Inflation rate
Let us say that, as a result of a decline in the inflation rate from 1 percent to -1 percent, central bank policymakers have concluded that a real interest rate of -0.5 percent is required to counter deflation, thereby preventing economic deterioration. At an inflation rate of -1 percent, this would require the central bank to lower the nominal interest rate to -1.5 percent. Since this is below the zero lower bound, individuals are likely to be reluctant to lend.
Likewise, it is argued that when the inflation rate is very low, this can also create problems. Suppose that inflation has fallen from 2 percent to 1 percent. At a nominal rate of 0 percent, the central bank can set a target for a real interest rate of -1 percent. It cannot aim at a lower real interest rate since this would imply setting the nominal interest rate below zero. As the economy weakens further, and the inflation rate falls to 0.5 percent, this will not allow the central bank to target real interest rates to below -0.5 percent.
In this way of thinking, a low inflation rate, or outright deflation, reduces the central bank’s ability to revive the economy. Hence, the policy of price stability must aim at a certain level of inflation, which will give the central bank the flexibility to keep the economy on the path of economic prosperity and prevent it from sliding into deflation.
The essence of all this is that inflation is necessary in order to have economic prosperity and stability. The inflationary buffer must be large enough to enable the Fed to maneuver the economy away from the danger of deflation. Mainstream economists hold that inflation at around 2 percent is not harmful to economic growth. They are of the view that an inflation rate of 2 percent seems to be good for the economy, but a higher inflation rate of 10 percent, for example, could be bad.
Why would an inflation rate of 10 percent or higher be regarded as bad? If anything, at an inflation rate of 10 percent, it is likely that consumers will form rising inflation expectations and—according to the popular wisdom in response to a high inflation rate—this will speed up their expenditure on goods to beat the price rises, which should boost economic growth.
Inflation is not about a rise in Prices
Inflation is not about general increases in prices as such, but about increases in the money supply. As a rule, the increase in the money supply set in motion a general increase in prices. This, however, need not always be the case.
In a monetary economy, the price of a good is the amount of money asked per unit of it. For an unchanged quantity of money and an expanding quantity of goods, prices can actually decline. The reason why inflation is bad news is not because of increases in prices as such, but because of the distortionary damage inflation inflicts to the wealth-formation process.
The chief role of money is as a general medium of exchange. Money enables individuals to exchange something they have for something they prefer more. Before an exchange can take place, individuals must possess something useful that they can exchange for money. Once they secure the money, they can then exchange it for the goods they want.
Now, consider a situation in which money is generated out of thin air by inflation of the money supply. This new money is not different in kind from counterfeited money. The counterfeiter exchanges the fraudulent money for goods without producing anything useful. He, in fact, exchanges nothing (the newly-inflated money) for something. He takes from the pool of goods without contributing to that pool.
The economic effect of inflated money is the same as that of counterfeit money—it impoverishes producers. The inflated money and credit also divert wealth towards the holders of this new money and distort the structure of production. This weakens the ability of wealth-generators to produce wealth, and this, in turn, leads to a weakening in economic growth.
Importantly, as a result of the increase in the money supply, what we have here is more money per unit of goods and, thus, higher prices, all other things being equal. Again, what matters is not price increases as such but the inflationary increase in money supply that sets in motion the exchange of nothing for something or “the counterfeiter effect.” Therefore, anything that promotes inflationary increases in the money supply can only make things much worse. Obviously, countering a declining growth rate of prices by means of an easy-money policy (i.e., generating inflation) is bad news for the process of wealth-generation and, hence, for the economy.
Furthermore, if a decline of prices emerges on the back of the collapse of non-productive bubble activities in response to softer monetary growth, then this should be seen as good news. The less bubble activity, the better it is for wealth-generators and, hence, for the overall production and consumption.
According to Rothbard,
Improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.
Also, according to Joseph Salerno,
. . .historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus, throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. For example, in the US from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75% per year, while real income rose by about 85 percent, or around 5 percent per year.
Conclusion
A policy of generating inflation in order to enable central bank policy makers to guide economic growth leads to boom-bust cycles and economic impoverishment. The emergence of deflation is always good news, since it is part of the process of the liquidation of various activities that cause the erosion of the wealth generation process.
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