Why is a low inflation rate preferable to no inflation?
1. Downwards stickiness in wages and prices. Wages in particular are very hard to negotiate downwards as people and trade unions are naturally very reluctant to accept nominal cuts in wages. However if downward adjustments were not possible the disequilibrium in the economy would cause instability and a lack of growth. A low inflation rate allows real wage decreases, while avoiding nominal cuts simply by having a wage increase rate lower than that of inflation. It is in this sense that inflation has been called the grease on the wheels of the economy. 2. Zero inflation increases the risk of the economy slipping into deflation and worse a deflationary spiral. The decrease in prices causes wages to fall and less goods to be produced, which in turn causes prices to fall further causing further decreases in wages, goods production and employment. A low rate of inflation provides a safety barrier against this. Deflation is also very hard for a monetary authority to correct. Interest rates t
