It only diminishes debt if your ability to service that debt outstrips the rate of inflation. If your ability to service debt does not grow in line with inflation, you are in no better state.
It's primary purpose is as a unit of account, i.e., to quantify the value of an asset. It's the assets themselves that are the long-term store of wealth.
In basic terms, inflation is the loss of purchasing power due to an increase of the monetary supply faster than economic growth. In plain English, this is where more currency is chasing the same number of goods and services.
This means your unit of currency buys less over time. What is 'wrong' with this is that inflation is a transfer of wealth—some people even go so far as calling it theft or a 'stealth tax.'
This is because the purchasing power that you had in your unit of currency isn't 'lost', it is actually transferred to the institutions creating the money. If you had $1 worth of pennies in your pocket, and inflation was 1%, it is like an invisible hand reaching into your pocket and stealing a penny. Do that a hundred times and you can 'create' $1, but by the time this is done, you will find that your $1 can only by 99 cents worth of goods and services now. In a fiat based, fractional reserve system that we have today in the West, the institutions that are reaching into your pocket (AKA creating money) are central banks and commercial banks.
For example, say the Fed (the central bank for the US) creates an initial $10m of reserve currency, this is then used by commercial banks to 'create' an additional $90m through loans from that $10m reserve. It is therefore commercial banks, not central banks, that predominantly create currency in society—and depending on growth and circulation (economists call this velocity) in the real economy, creates inflation. You see if the creation and circulation of money was perfectly in line with the growth of the economy than there would be no inflation. The real problem is that the growth in monetary supply has far outstripped the growth of Western economies. Indeed there is a compounding effect of inflation.
But yeah, I can understand that this material may seem unbelievable... I have included a URL to a YouTube video where a Bank of England (the central bank of the UK) representative actually says in no uncertain terms that commercial banks create most of the money in the economy.
The important passages are:
"...banks create additional broad money whenever they make a loan"
"Now, while this is nothing new, it's sometimes overlooked as the main way in which money is created and it runs contrary to the view sometimes put forward that banks can only lend out deposits that they already have."
"In fact, loans create deposits, not the other way around."
> if the creation and circulation of money was perfectly in line with the growth of the economy than there would be no inflation.
While this is technically true (at least for some interpretations of "inflation"), it's important to realize that the wealth transfer effect you describe still occurs in this case. The only way it would not occur is if the newly created money was distributed exactly in accordance with the current allocation of money: in other words, if the economy grows by 1 percent, every current holder of a dollar gets a penny. But of course that's not how money creation is actually done.
Yeah I wish this was taught in public school. Also I think that part of the problem is that concepts like 'wealth', 'purchasing power' or 'the time value of money' aren't discussed at all until first year University courses in Finance.
I wish more people understood that most of the time wealth is transferred, not destroyed.
