Why does inflation matter that much? What is the "real" deal? Inflation isn't necessarily bad if it is contained to around 2-3 per cent. Obviously, anything above it isn't desirable because it can affect the economy. A case in point is Zimbabwe. In fact, a low inflation rate is desirable.
Now, consider a country that has deflation — that is, the opposite of inflation, where prices are falling. While it may seem good on the face of it, it's in fact bad for the economy.
Effect of deflation
Japan, for instance, has had deflation from the early 1990s till recently, and its economy has been in bad shape since. What deflation does is when the prices of goods are reduced, the profits of companies fall and they hire less people. People, anticipating possible layoffs, start saving more and consuming less. When consumption is reduced, it will reduce the demand for goods and therefore their prices, again leading to further reduced profits for companies. And this typically leads to increased idle capacity.
When companies have reduced profit, it reduces their ability to pay back loans and this then starts hitting the banking sector. The only way for the central bank to come out of this situation is to reduce the interest rate. But once interest rates are lowered, people are actually unwilling to invest long-term in banks, which further worsens the recession.
Zero interest is called liquidity trap because at this rate banks are unwilling to lend money and the liquidity that the central bank created has been trapped in banks that are unwilling to lend. To get out of the liquidity trap, Milton Friedman made this fanciful suggestion: that the central bank take hoards of money in a helicopter and drop it in the streets, so that people and companies get money directly!
Signal to investors
Inflation matters because it is a signal to investors that an economy is being managed well and that it has good overseers. Every episode of high inflation the world over has always been the result of gross economic mismanagement and investors are right to use that thumb rule.
The other thing about inflation is that it defines what is "real", in other words, the nominal minus the inflation rate. The real number is what concerns investors. What will be their real return, etc? The reason is that inflation can lower the value of a currency and this can be a bit of a problem for investors when they need to repatriate profits.