Most central banks aim for 2 percent inflation. This has little to do with price stability, as officially aimed for. Rather, it is a recipe for rapid monetary destruction.
Stable prices are constant prices, but central banks usually see things differently.
It’s hard to see anything positive about the pandemic. However, from a folk pedagogical point of view, it could be said that public knowledge of the laws of mathematics has increased over the past two years. Since R-values have been talked about at regular tables as if they were football results, more people are aware of the dynamics of exponential developments. So it’s no longer a secret that even small changes can have a very big effect if they last for a while.
The two sides of compound interest
Now it would be time to apply this knowledge to a new topic: inflation. Because in the slipstream of the pandemic, currency depreciation has also increased rapidly in recent months. And similar to the spread of the virus, things are developing far more dynamically when it comes to inflation than intuition would lead you to believe. The compound interest effect ensures that even supposedly low inflation rates are sufficient to significantly reduce assets over time.
It is correspondingly irritating that most central banks – the Swiss National Bank (SNB) is a notable exception – aim for an inflation rate of around 2 percent. Such a rate has little to do with price stability in the literal sense. Annual taxation of “only” 2 percent means that the value of money is halved within 35 years. And with inflation of 5 percent, as is currently the case in the euro area, the sum even melts to less than a fifth of the initial amount in the same period.
The compound interest effect, once praised by Albert Einstein as the “eighth wonder of the world”, is not just a welcome contributor when accumulating a credit balance. If the signs are reversed, the same effect is also suitable for rapidly decimating the savings over time. Therefore, if the goal of price stability were to be taken seriously, central banks should actually be aiming for zero percent inflation. All other targets simulate a constancy that cannot exist with positive inflation.
Neither curse nor tragedy
Certainly, there are understandable reasons to aim for slightly positive inflation. Some see it as a lubricant for the economy, for example, because spending is not postponed in the hope of falling prices and because real wages are easier to adjust downwards with some inflation. Monetary authorities are also aiming for a certain buffer compared to the zero interest rate limit. This limit is quickly reached when inflation is very low, which means that the central banks can only intervene to a limited extent to stimulate interest rates in the event of a crisis.
Nevertheless, this safety margin does not have to be two percentage points – and certainly not five percentage points. What is currently taking place in the euro area is an excessive destruction of monetary value. The trivialization of such actions by the heads of the European Central Bank (ECB) makes things even more difficult to bear, especially for people with few physical assets who can hardly defend themselves against the loss of purchasing power of their wages or pensions.
One day the pandemic will end and the analysis of R values will lose its excitement. Then the public should use their newfound skill in dealing with rapidly rising numbers to analyze inflation. That would increase the pressure to confront the evil more decisively. Because what Ludwig Erhart said in 1957 still applies today: «Inflation does not come over us as a curse or a tragic fate; it is always brought about by a frivolous or even criminal policy.” Unlike the pandemic, the excuse that you didn’t see the danger coming doesn’t apply.