walkitout (walkitout) wrote,

Where _Does_ Inflation Come From?

Let's go back to the goat and chicken analogy.

Back when everyone (for suitable definitions of everyone) had to participate in some form of food production (extraction, whatever), that cycle had a profound influence on, well, everything.

In the spring, there was a whole lot of worrying about whether you'd have enough to eat while you were planting and hoping that something grew. Summertime was a little better; fall was fantastic (except when it wasn't) -- enough to gorge and share and charge very little and have enough to pay off debts incurred earlier in the year. A traveler trying to buy food in the spring had a tough time of it; it was easy to do in the fall, and easy to find work then, too.

Livestock on a farm was an opportunity to level out the highs and lows of the spring/fall cycle: if you could pile up enough grain in the fall to keep your layers and milkers over the winter, you'd get free additions and/or replacements in the spring, instead of having to buy from someone else. The more you could keep, the better, and you'd have milk and eggs to eat as well. You had to do something with the males; the obvious thing is to eat them. If the pile of grain was the equivalent of money in the bank, then meat on the hoof was the agricultural world's version of a blue chip that pays a dividend. (<-- A very backwards analogy!) In a bad year, a lot of people might eat some or all of their milkers or layers, or sell them -- but that was a whole lot better than what would happen if they didn't have them to eat or sell.

When anything interrupted that cycle, it was easy to wind up with whatever money existed chasing after not enough goods. War took workers who would otherwise plant and harvest (and everything in between) and replaced them with thieves and criminals, or whatever you want to call the opposing team looking for food and supplies. And then there was weather and its close companion in distress, pests. In times of instability, you not only found a high level of prices (that would be inflation), but you also found people turning 5 metal coins into 6, if they weren't manufacturing entirely fake coins out of lead counters and silver paint.

So inflation came from too much money chasing too few goods, with a sauce of questionable money.

Anybody who has bought something in an auction on eBay knows that too much money can still chase too few goods (a long out of print lunchbox, say) and have the effect of driving up prices (that would be what inflation is). On a more serious note, whenever something very essential (notably, fossil fuel) is not as available as we would collectively like it to be, prices tend to rise. Fossil fuel is a really good example, because we use fossil fuels to do just about everything (raise food, warm shelter, make stuff), so more expensive fossil fuels result in more expensive everything (again, that is what inflation is).

When there is an expectation that there will be a shortage of something desirable (whether that expectation is based in reality or not), that shortage will probably occur. Hence, if you expect you won't be able to buy things at the grocery store because of severe weather and thus might run out of milk and bread, you might go to the store in advance of the storm. The effect -- whether the storm happens, or blocks road use or not -- is the same: no more milk and bread on the shelves. Similarly, if people expect prices to go up, their behavior, particularly when it comes to signing financial commitments (contracts, loans) will have the general effect of causing prices to go up.

The same kind of thing can happen with expectations about the economy in general. For a period of time starting a little before I was born, and extending to the beginning of the 1980s, there was an expectation that the economy would grow, that there would be jobs for everyone (literally), and that wages would keep pace with whatever inflation might occur. This expectation was created by a lot of things, including but not limited to a demographic bubble and the postwar reconstruction of everywhere, fueled in many ways by US industry. Partway through this time period, several things happened that aggravated the general increase in prices: wage and price controls were removed, the ability of Texas and other domestic production areas to increase supply when demand increased went away (that is, peak oil occurred in the lower 48, effectively turning price control on fossil fuels over to producers outside the US), and a few other odds and ends as well. The details involving which of these things was more important than which other of these things are the subject of ongoing debate, but the effect was very strong inflation in the US.

There are some other things that can cause massive inflation across a country. It is possible to have significant inflation without a shortage of goods. Hyperinflation has occurred in several times and places in a way that had virtually no impact on the prices of goods when considered in terms of other currencies, but when considered in the current local currency were doubling in price in a very brief period of time (on the order of a day, sometimes). Generally speaking, this only occurs when there has been a widespread and relatively complete loss of faith in the issuer of the local currency, and alternative currencies are available in some form. You can get hyperinflation in other ways that has a real inflationary impact on prices of goods considered in terms of other currencies (so you can have "real" inflation with hyperinflation), but it takes some effort.

Generally speaking, inflation is a mechanism for transferring wealth from people who have it (creditors) to people who do not (debtors). It has a strong impact on people who have liquid wealth (money) and who loan that money to other people at interest, and on people who have signed contracts to pay a certain amount of money, possibly at particular intervals. People who have wealth that can be appraised in money but which is not liquid (stock representing partial ownership of a company, a house, a car, cans of food, collectible lunch boxes) are not strongly impacted. People who work for pay, but have the capacity to renegotiate the rate they are paid to reflect current price levels are minimallly impacted. From this perspective, inflation reflects a general opinion that the incomplete transactions represented by the debt/money are worth less now than they were before. Sort of a gigantic "what have you done for me lately".

If the money in circulation is produced by a monopolist, there is always the chance the monopolist will create a whole bunch of money so they can extract stuff from the group with that money. This is usually detected pretty quickly, and coped with by inflation.

If the money in circulation is produced in a distributed way, there is always the chance that a whole lot of money will be created, backed by promises of future payments. When there is a lot of money from the distant future buying stuff in the here-and-now, the effect is, again, too much money chasing not enough goods (that would be our recent housing bubble).

Responsible Policy Makers (a category which includes central bankers, and a whole lot of other people, too. The word "Responsible" here is not a description of their character or intent, but rather a description of who we will blame if we don't like the outcome.) are often trying to manage the amount of money in circulation, with any of a number of goals in mind. They might want to help creditors (cause deflation, a subject for another post), debtors (cause inflation), or maintain the status quo (benefiting people who want to be able to predict the future accurately). There are a variety of strategies for doing this, some of which are more reality based than others, and all of which tend to discover unexpected effects when deployed. As with everything else having to do with people trading chickens and goats, er, stuff, there are people who look at this from a supply side (how many chickens are there? how many goats are there?) and people who look at it from a demand side (how many chickens do we actually want? how many goats do we want?). Which perspective one takes strongly influences but does not necessarily determine which policy options one might consider attempting.

There are people right now who are very worried about the return of inflation. Their thinking goes something like this: the government is spending a lot of money, money which it does not "have". One or both of two things is about to happen. (1) There will be too much money sloshing around, and we will have inflation (Real inflation). (2) People will not trust our currency, and we will have crazy, Weimar style inflation (hyperinflation).

Here are the problems with this argument. The first one is unlikely, because there is a godawful amount of stuff available to buy, and there are a lot of people to hire to provide services. Ergo, we are not looking at a situation where there is too much money chasing not enough stuff. The second one is unlikely for an incredibly long list of reasons that I'll probably get into in the appreciation/depreciation post, which I'll get into after the deflation post, but it comes down roughly to the idea that currencies exist in a larger context, and hyperinflation tends to involve people being in a screaming hurry to get out of one and into another. If you can't think of another currency worth being in, hyperinflation will probably not be the main problem with the currency you are currently use.
Tags: economics, political economy outline, politics
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