It’s a matter of degree; 25% inflation is much worse than 5% inflation. Some countries (eg Russia and Serbia) have recently had hyper-inflation with prices rising by up to 1000% pa! Low inflation, such as the 2% or so the UK has at present, is not a real problem.

The UK has had a big problem with inflation in the past. It rose to 28% in the late 1970s. This caused significant problems with growth and employment. The memory of this time makes the government very determined now to keep inflation under control. Why?

1. Inflation distorts prices between different time periods. Normally, people save some money, and there is a balance between savings and spending. Savings go to banks where they become loans for business investment. If there is inflation, you’re better off spending the money now before it loses its value, so consumption now rises at the expense of consumption later; savings are money you plan to spend later.

2. Instead of saving, consumers may start borrowing. £10 000 borrowed now will buy lots of things, and by the time you repay it in a few year’s time, the £10 000 is worth less, and is probably easier to repay if your salary has risen because of inflation. So consumers tend to borrow more and spend even more.

3. Interest rates rise. If a lender normally wants 5% to let someone else use the money for a while, and inflation is also 5%, then the lender will want 10%. This puts up business costs and makes borrowing less and therefore investment less; less investment means less growth and employment.

4. Inflation causes uncertainty which increases risk. Higher risk means businesses are less likely to invest, with the results mentioned in 3.

5. Inflation re-distributes wealth and income. People with fixed incomes eg some pensioners see the real value of their income fall (they become worse off) and other people get pay rises to compensate for inflation (they become better off). Wealth moves from savers to borrowers eg house price inflation makes the owners of houses much better off, and the mortgages become easier and easier to repay.

6. Input prices (raw materials, wages and supplies) rise so business costs rise. Wages are often the largest business cost, and there could be a danger of a ‘wage-price’ spiral where rising costs leads to higher prices, workers ask for a pay rise in compensation, so costs rise again, so prices rise again, and so on.

7. ‘Shoe-leather’ costs. Because prices are always changing businesses and consumers spend a lot of time looking for the best price (walking up and down the high street) which is a cost and they may not find the best deal, which is another cost.

8. ‘Menu costs’ are the costs of constantly changing prices as in the literal example of reprinting the menu. But it’s not just the price labels on the goods, but the whole business system that has to be changed.

9. Wage negotiation. If there is inflation, workers will want pay rises. The actual time and cost of negotiating this, and making the necessary administrative changes can be quite high. Whilst managers are negotiating, they aren’t doing anything else.

10. Asset-price inflation. Houses, shares and other investments (even art & antiques!) often rise in price during inflation as investors look for a safe haven for their money. These prices then rise due to strong demand, which attracts further buying. So normal spending patterns are changed because of less spending on normal goods and services and more spending on assets. This switch reduces demand for normal businesses and creates an artificial ‘bubble’ in these other markets.

11. Trade. If the UK has higher inflation than competitor countries (which it isn’t now, but it has been for a lot of the last few decades) then UK prices gradually rise above imported prices. More imports are bought, so demand leaks out of the country and leaves UK businesses in a weak position. The same effect occurs with UK export businesses. The eventual effect may be a fall in the £ which puts prices back where they were, but leaves UK consumers worse off because they can buy fewer imports than before.

In June, the Federal Reserve Bank's policy-making committee — a group dominated by bankers and other corporate interests — voted to launch a “preemptive strike” against inflation and raise interest rates. Just a tad, only a quarter of a percentage point. But the rate hike, which increases the cost of money to banks, could be the opening salvo in a determined campaign to choke off credit and slow economic growth.

Critics chastised the Fed for slowing growth when prices are not, in fact, rising. Thanks to rapid technological change, critics say, there is a “New Economy” in which U.S. workers are highly productive and U.S. markets ultra-competitive. In this economy, wages can rise without sparking inflation.

Talk of a “New Economy,” however, begs a larger question. It may be that wages can rise and unemployment fall without prices rising, but what if they could not? Is inflation so awful that jobs and incomes must be sacrificed to prevent it?

It has become an article of faith in the mainstream media that inflation is destructive and that any and all tools should be used to combat it. The idea is constantly invoked but never defended. When the Fed, in a statement released after the June meeting, spoke of “inflationary forces that could undermine economic growth,” not one commentator questioned the presumption that inflation causes harm.

Yet neither history nor logic supports this view. Moderate inflation in fact seems beneficial to market economies. When prices rise generally, small businesses gain pricing flexibility and relief from competitive pressures. Employers in inflationary times find it easier to grant pay raises without demanding more work in return. For the heavily-indebted middle-class, moderate inflation is a positive godsend, lifting incomes while whittling away the real value of mortgages, auto loans and credit card balances.

Evidence abounds that countries willing to tolerate moderate inflation are able to sustain higher rates of job growth for longer periods. And, as just mentioned, inflation redistributes wealth from the rich to the indebted middle-class. It is not an accident that the moderate inflation of the 1960s and 1970s coincided with more egalitarian distribution of income and wealth, stronger unions, and greater democratic ferment throughout the United States and Western Europe than in the 1980s and 1990s. When conservative central banks began suppressing inflation in the 1980s, high unemployment followed everywhere. In the U.S., unions were routed by the high unemployment rates of the anti-inflation campaign of the early 1980s. This continuing campaign has since concentrated wealth and income to an extent not seen since the 1930s. In Western Europe, anti-inflation forces substantially weakened social-democratic protections and permanent joblessness now afflicts millions.

The greatest threat to the economic well-being of workers is not inflation but falling prices (deflation). When economies slow, prices fall, as they did during the Depression. Small businesses and workers lose income, yet their debt burdens remain the same. Unable to pay off loans secured when prices were higher, the indebted are driven into bankruptcy. These foreclosures breed unemployment, further defaults and drops in income. Much of Asia is now suffering deflation. With U.S. inflation now close to zero, the Fed's policies slowing growth could spark a deflation in this country, severely damaging the prospects of American workers.