Bronze-level articleInflation

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Inflation most simply is a growth in the money supply without an additional backing by product. Today, under fiat currencies, it's normally redefined as and measured by price levels using the Consumer Price Index (CPI) or core inflation, which is the CPI minus oil and food (as those commodities are more volatile). A small rate of inflation is the natural by-product of a growing economy. It was summed up by Milton Friedman as "too much money following too little goods."

Contents

[edit] Causes

There are three types of price inflation agreed upon by modern economists:

  • Cost-push: Where supply-side effects create the rise in prices, such as, for example, a depleting metal rising in price, because the cost to extract each unit of metal rises as it becomes more scarce.
  • Demand-pull: Where demand-side effects create the rise in prices, such as with fuel, where the newly industrialized East Asian countries need oil, and thus demand huge swathes of it too, raising overall demand for fuel from the industry, or where money is simply printed, leading to more spending with no concurrent rise in product, causing demand for the same number of products to rise, and thus raising prices also.
  • Too large money supply compared to the economy: If the size of the money supply grows relatively larger than the value of economic activities, prices of the economic activities go up.

[edit] Macroeconomic Role

[edit] Keynesian Interpretation

Inflation is one of the core econometric gauges used by economists to measure an economy. In the 1930s-1970s Keynesian Era, it was general consensus among economists that unemployment mattered most - unemployed workers were effectively idle and thus wasting energy that could be used to produce, creating stagnation. However, the 1970s created a strange coexistence between high unemployment and high inflation, appropriately called "stagflation". This resulted in a paradigm shift in economics, whereby economic efficiency became a focus. It's all well and good to have 20% of your population staffed in the military, mining coal or producing crappy cars, but if nobody wants it, you're effectively paying people to spend money when the product they have created is valued much less, with the result being high inflation.

[edit] Monetarist Interpretation

With this realization, economic policy since the 1970s has generally revolved around "inflation targetting", and has been termed Monetarism. Under this interpretation, the Great Depression resulted from deflation. As banks create money by investing out money invested into them, bankruptcy of the banks' investments effectively causes the money supply to contract, creating deflation. As each unit of money buys more, people reduce spending, anticipating future spending potential--causing the economy to fall back to equilibrium. This is popularly termed a "market correction", as it forces less-liquid investments out of the economy, allowing investment in more-liquid (and hence more efficient) assets. However, an issue with deflation is that, in cases like the Wall Street Crash, people rushing to save causes more banks to crash, creating more demand for saving, and so on. This quenching of demand and causing more foreclosures is termed "deflation spiral".


Meanwhile, high inflation is interpreted as inefficiency in the economy. For example, from 2003-2007, the Sub-Prime Mortgage Bubble saw inflation rising far beyond the target rates. This was because of the vast sums of capital invested into the unproductive housing market, effectively raising prices without increasing other markets' income, effectively taxing productive industries and subsidizing the bubble. With economic growth slowing but inflation holding out, the central banks had to raise interest rates to curtail the supply of money and cut inflation, forcing an enormous economic correction. As deflation took hold, these corrupt, crony banks were then fed more capital to fight it. As corrupted stimulus spending joins this with held hands, inflation is once again rising, with unemployment not budging from impressively high heights.


Hence, too much inflation has the effect of taxing the productive to subsidize the less productive, creating deadweight loss through supply deficits, whilst negative inflation has the effect of putting a cap on demand and creating deadweight loss through demand deficits. Zero inflation is ideal as a state of equilibrium; however, economists generally agree that 1-3% inflation is a nice figure because consistent depreciation of currency creates elementary levels of demand, and reduces the likelihood of excess hoarding of non-productive assets.

[edit] Austrian Interpretation

Despite Monetarism only really being properly practised in Europe (aside from one country in particular failing specularly for unrelated reasons), in light of the recent mass failure of governments to alleviate the economic strife, people have presumed that it is intrinsically at fault, and alternative/unorthodox economic schools have risen to prominence, particularly the Austrian School. The Credit Cycle Interpretation proposed by Friedrich Hayek nearly mirrors the Monetarist interpretation (except that it proposes that deflation spirals do not exist, and are just a sharp return to equilibrium, and that state monetary policy is ultimately disequilibriate and inefficient, often because of back-hand deals by special interests). Almost all Austrian School Economists advocate the gold standard, claiming this would force inflation back out of the hands of corruptible people. This, however, would seem to fail as an alternative, as it presumes that the quantity of gold will be perfectly in line with true economic growth. This may have been true in the 1800s, where the effectiveness of gold mining was very closely in line with the rest of the economy's true productive output; but since the 1920s, economic growth in other areas has vastly outpaced the extraction of this metal. Not to mention that with its relatively new application in semiconductors, gold has followed silver in developing a genuine commercial value, rather than just being a store of value.

[edit] Hyperinflation

Marks are in style this year!

There is no technical threshold for hyperinflation, but economists usually follow the description by Phillip D. Cagan[wp] which is 50% monthly inflation[1]. Hyperinflation tends to create a positive feedback loop where faith in the currency is lost so people spend as much as they can as fast as they can, driving prices up even higher.

[edit] Econo-geddon!

So what's all this talk about hyperinflation and economic Armageddon? I mean, Glenn Beck keeps telling me we'll be burning money for warmth soon.[2]

Well, he warned about it in 2008, and then 2009, and then 2010. Oops, CPI actually went through a deflationary period in 2009 and was at just over 1% at the end of 2010. Core inflation has been steadily falling since 2008. Well, Beck has to sell his gold, gold, gold! And so do a lot of scam artists who like to stoke hyperinflation fears.[3] Makes you wonder if gold is the way to go, why do they want to sell it to you instead of hanging onto it?

The fact of the matter is that the US is a global economic superpower with a gigantic intertwining globalized economy. Contrary to Glenn Beck's assumption that dollars are being thrown away, many nations are flocking to it, as they have faith in the central banking system of the US to not renege on the promise to return an equal value of product per unit currency, and on the dollar to be a good relative store of value. There are even entire black markets in states like Venezuela and North Korea, where the government forces their own currencies to be much too overvalued, and its own population find the store of the dollar to be so much more appropriate that they risk death to hold dollars instead.

In a bitter sense of irony, the dollar is far more likely to be forced to hyperinflate by a crash resulting from the perpetually extensive war-spending and anti-science attitudes of these conservatives, than of a few billion dollars of quantitative easing (however silly) into the M3 money supply, in an economy with a value of trillions.

[edit] The US is not the Weimar Republic

Printing money? Weimar here we come! Oh noez!
"Printing money" has become synonymous with the Weimar, but all nations with sovereign currencies have to print money at some point, otherwise the money supply could never expand (obviously). So what's different about the Weimar?
  • Massive war reparations that some economists warned were much more than Germany could hope to pay back, piling a massive debt on top of a country already torn apart by World War I.
  • The country was stripped of its colonies and France swiped some of its manufacturing centers and natural resources.
  • Monetizing debt all at once to make payments on time.
  • Dr. Rudolf Havenstein, President of the Reichsbank, refused to believe that there was any connection between the money supply and the rate of inflation.[4]
  • Members of some social groups, like farmers and unionized workers, initially suffered far less from inflation than others, especially pensioners.
  • Political instability: the democratic center of liberals and social-democrats lost popular support to the authoritarians of the right and extreme left.
  • The hyperinflation came to an end when Germany moved to the Rentenmark, which was backed by land.[5]

[edit] The US is not Zimbabwe either

In the early 2000s, Zimbabwe enacted land reforms that ended up destroying its agricultural base, which made up most of their economy. So they had no food and printed tons of money to import some. Recipe for disaster. There's a common thread here: Hyperinflation tends to happen in nations that have a very weak and non-diverse economy or problems with political stability. Don't start stuffing gold under your mattress just yet. And even if the dollar does go kaput, in that case, you're going to have way more things to worry about than how many gold bars you've got.

[edit] See also

[edit] Footnotes

  1. In accounting, the threshold is usually doubling price over 3 years, which is much less than what the economists use.
  2. Beck Continually Warns of Inflation
  3. Dismantling Hyperinflation
  4. Adam Ferguson. 1975, 2010 reprint. When Money Dies. New York: Public Affairs. pp. 170-172.
  5. As We Go Marching, John Flynn, 1944, p. 92.
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