I’ve been wondering this question for a while. Ignoring current events, why is a little bit of inflation desirable?
I do understand that it’s done to “stimulate” the economy so people don’t let their cash rot in a checking account, but isn’t it a zero-sum game? Everybody says that money is not meant to stay where it is, rather, should flow through the economy. But if the economy always needs injections of liquidity because otherwise it fails, isn’t the economy broken?
I feel like there’s something I can’t comprehend about that.
I think the real key to understanding how inflation can be desirable is to understand that when economists talk about inflation it is with the assumption that wages will rise by an equal amount.
And, generally speaking, this is actually true. There’s a lot of nuance to that statement, so please just trust that whatever counter you have is probably contained in the nuance. But, broadly, the math checks out. We will dig into that more, later. I promise.
So, the notion is that prices go up by 2%, and then your wages go up by 2%. So how does that help anything if all we’ve done by the end of the year is reset the status quo?
Well, there are two numbers that don’t get immediately affected when your pay goes up; your savings and your debts. With slow, gentle inflation, both of these things will, over time, shrink relative to your income, while your actual buying power should, ideally, remain the same.
Say you buy a car and you agree to pay $300 a month for it. Five years later, your pay has gone up by 10%, but your car payment doesn’t go up. It’s locked at the price you agreed at the time, meaning it’s now a smaller slice of your income.
Conversely, your savings effectively shrink every year. The combined effect of this is that people with lots of savings are encouraged to spend them, while people with lots of debts are rewarded. That means more money moves though the economy, creating a healthier economy, and it means that governments, who hold lots of debt, get to shrink that debt without ever having to pay it down. The UK government still holds debts from 300 years ago, because what was a massive expenditure at the time is now just a pittance. This is why governments can run permanent deficits (within reason) and not ever have to worry about the bill coming due; because it doesn’t.
For individuals, mild inflation benefits those who buy things on credit rather than outright, which under normal circumstances means us regular shlubs who need mortgages and car loans.
If you’re trying to understand why every business now cares only about juicing their share price and not about their long term health as a company, this is a big part of why. As inflation bites, the wealthy watch as their assets decrease in comparative value, so they want those assets to grow faster than inflation. That leads to a growth at all costs mentality.
So why isn’t this working? Well, one problem is the one I just mentioned; we’ll get back to that.
But the other reason is that not all inflation is the same. When prices go up because the economy is running hot, it means that the price of everything goes up. Everything includes your labour. But when prices go up because a pandemic made shipping more expensive, or because someone started a war in Iran, that increases the input costs your company is paying for whatever it is they do, but not their profit. So your boss doesn’t suddenly have a bunch of extra money to give you a pay rise. The value of your labour hasn’t increased, but the cost of things has. So we get price inflation without wage inflation.
So this is the real disconnect; there’s good invitation and bad inflation, and they’re not the same thing (and, frankly, the fact that we don’t have different terms for them is the cause of a huge amount of confusion and misunderstanding).
Healthy inflation is the natural result of growth in an economy. Economies tend to grow, because the human population of Earth tends to grow, which means more people doing more labour, making more stuff and buying more stuff. And of course, over time we develop new technologies and practices that increase the amount of goods each human can produce, which increases what each human can sell and thus what each human can buy.
(A quick aside here; the math generally seems to agree that global population will actually stabilize at some point, probably at around 10 billion. So the human growth portion of this equation is probably only over a specific timeline, and that’s without even factoring any kind of intentional degrowth.)
The problem is that what we’ve been seeing for much of the last decade isn’t inflation, it’s price shocks, the “bad inflation” that I referred to.
If you think back past 2020, you’ll recall that the word inflation really wasn’t in the public vocabulary in the same way. It was really only something that was being talked about by weirdo libertarians, who then used the combination of price shocks and massive government spending in the pandemic to sell this notion that this why governments shouldn’t spend money. This, of course, completely ignores that governments across the world spend truly unimaginable amounts of money resolving the financial crisis just ten years earlier and inflation remained so stubbornly low that Japan had to go out of its way to try to create some.
So, in short, moderate, controlled inflation good, price shocks bad.
In theory.
But of course, there’s more to it than that, because we all agree that the quality of life we can afford today and the quality of life we could afford even as recently as the 2000s are not the same thing. The Simpsons are supposed to be a working class family barely getting by and they live in a palace by modern standards.
This is because the way we measure “inflation” doesn’t work. At least, not for our purposes. To put it really simply, if you compare what we have now against the nineties, as a portion of our income TVs and computers have gone way down, while houses and college degrees have gone way up. That’s the problem. The things we want are cheaper while the things we need are more expensive. And as income inequality worsens, this problem only gets worse, because the wealthy can afford to buy up all the assets like housing, raising their price.
The other problem is that wages increasing in line with inflation relies on labour having the power to demand increased wages, and that’s something that’s being steadily stripped away from the poorest workers. Your six figure workers can still generally demand regular pay increases, or hop jobs for a bump, but the guys pulling shifts at McDonald’s aren’t seeing those same opportunities. So while, in aggregate, wages do tend to keep up with inflation, in reality the distribution is skewed. This is where governments need to step in with things like minimum wage increases which bring the floor up for everybody (this is why, in practice, minimum wage increases have never been observed to increase inflation; they’re just correcting the side of the equation that’s currently unbalanced).
So yes, steady, moderate inflation is good… And has absolutely nothing to do with why everything is unaffordable now.
Monetary theory is complex, and lots of stupid people want it to be simple.
Inflation is a measurement, for starters. it’s the change in the price of of something. the general inflation rate is a index measure, it’s not a true measure of inflation, let alone inflation of any one type of product or service.
prices always change, but generally price stability is good, we prefer price stability to price instability, because it’s predictable and allows us to plan for the future.
inflation is easy to understand if you stop thinking about it as piles of money, and think about it in terms of how people interact with each other. people don’t want to socialize with unpredictable people.
further, some inflation is good, some is bad. people like housing and stock price inflation, because they are investments, they don’t like inflation in food, fuel, and consumables because those are not investments, you can’t sell the food you ate to someone else, but you can sell your home or your stocks.
Rich people love when number go up
Inflation also reduces the value of existing debt.
It’s desirable to the wealthiest, not the general population.
Edit: Some sources
https://360library.com/economics/deflation/common-misconceptions-about.html
This lists a couple of “recent” historical examples you can verify.
And here’s a more detailed analysis:
I thought this was about something else.
Focus on simplicity rather than details:
Deflation (opposite of inflation) encourages people to put money under the pillow and wait for it to increase in value. If everyone does this the economy stagnates.
Inflation encourages people to spend the money now or invest it. Your spending is someone else’s income and their spending is your income. Investing is you risking your money to have someone else buy something that hopefully makes them more productive.
Too high inflation causes loss of trust in the currency and people start hoarding bricks or something else non perishable and the economy stagnates.
So central banks say that they will manipulate the currency so that the inflation is around say 2% which is low enough for people to trust it but high enough to encourage spending/investing.
Just want to point put the whole “Deflation makes people not want to spend” thing is bullshit conjured up by a wealthy economist.
In reality the inverse happens - deflation makes the general population spend and inflation makes people save. This is because if you’re expecting things to get expensive, you stop spending on things you might want so you can have money for emergencies and things you might need. This isn’t even theory - you can just look at historical spending patterns.
Inflation primarily benefits the wealthy, because hoarding billions is pointless under deflation.
This songs like it makes sense, but a reference would be very useful
https://360library.com/economics/deflation/common-misconceptions-about.html
This lists a couple of “recent” historical examples you can verify.
And here’s a more detailed analysis:
So inflation isn’t actually good, it’s an active economy that’s good
Inflation itself is also good, assuming your salary goes up at the same rate.
If you take out a home loan, then over the 30 years you pay off the house, the mortgage payments make up a smaller and smaller part of your paycheck.
Same for car loans, and student loans.
Basically, inflation encourages smart use of debt.
so basically inflation is good only if you are one of the wealthy ones. being able to get a job that pays enough so you dont have to live hand to mouth. can even get a loan, pay it off and still have some money left over to maybe live. Also having a job you can trust doesnt kick you off at moments notice is also required to even consider any debt.
Over the long term, wages go up. Over the short term, people get left behind.
There are lots of things that suck for individuals, but are good for the economy as a whole. There are also lots of things that suck for the economy as a whole and are great for a select few.
Yes, but a healthy economy becomes more active if there is a healthy inflation to provide additional lube. 2% is roughly where inflation offers pretty good lubricant without being a pita
It’s worth calling out that there’s no real justification for that 2% figure. It’s a number that was pulled out of the air by the New Zealand version of the Fed in the late 80s, and it seems to work well, so everyone copied it.
There’s pretty broad consensus among economists that deflation is bad, and that inflation above about 3-4% is bad. Beyond that, we’re literally just guessing.
Inflation, especially unexpected inflation, benefits debtors. The biggest debtors in the world are governments. It’s not zero sum. It creates winners and losers.
This is the best answer. At just 2% inflation, by the time you’re paying off that 30-year bond, it only costs 50%. Government can stay in perpetual debt, pumping money into the private economy, and inflation effectively pays off the debt.
yes, but this also assumes growth.
Sorry for the pedantry: zero sum means it creates winners and losers, because you can only give someone more by taking it away from someone else. “Not a zero sum” means you can create winners only, because you can generate value to give someone without taking it away from anyone else. Economy is never zero sum: a bad economy is bad for most, and a good economy is good for most. Cronies exploit poor people in both good and bad economic circumstances.
Let me add: I’m an engineer. By reason of existence, my work involves improving how we do stuff. My work involves helping people work more efficiently, use fewer resources, cost less etc. We should be doing more, with less because the tools and methods get better. So why do things keep getting more expensive? I don’t grok inflation. Not a bit of it.
Theoretically wages should be getting bigger to at least keep up with inflation (due to improving technology and the like they should be beating it), but in practice capitalist greed means it doesn’t always work that way.
I’m also an engineer, and in my experience a reduction of blue collar workers gives only a temporary reduction of the work force; soon enough there will be more cost controllers, HR business partners and officers for all kinds of non value adding stuff. In my country we’re at the point where the people with bizarre job descriptions on LinkedIn are always posting about how to effectively employ the work force.
The right way to look at how expensive things are is to normalize prices to other things that also change with time, for example wages and expectations.
A car may be more expensive now than in 1960, but the car is faster, safer, more comfortable, and more people have one now.
Same with many improvements- an iPhone today is more expensive than a Nokia 3210 was in 2000, but it has more features and more people have one.
It is against human nature to stay where we are and just use improvements to reduce the amount of work we need to do. We want to have more. That may be a bad thing for sustainability, but we typically expect our governments to support that kind of progress, hence the dual mandate of the central bank to maintain economic growth with a high level of employment and a low level of inflation.
It is against human nature to stay where we are and just use improvements to reduce the amount of work we need to do.
To be clear though since the industrial revolution and until WWII improving technology has both improved quality of life and reduced working hours. The fact that working hours have stagnated at around 40/week is a historical exception that doesn’t get fully or even mostly explained by “we have more and better stuff;” if that was it we should be working 20 hour weeks by now. For more see David Graeber on the subject.
There is a lot of inequality that plays into this.
If you think about 90s Goldman Sachs style of 80-100 hours weeks, no weekends, no holidays culture that dictated “work ethic” expectations in American white collar jobs, to the post covid hybrid work and “quiet quitting” culture: I think the typical white collar worker works way fewer hours than 20-30 years ago, even though contracts said 40 hours the whole time. Anecdotally, a cushy office job at individual contributor level can be apparently kept while working maybe 1-2 hours a day. I know those are not typical, but it’s way more common than it used to. And my perception is that taking weekends and holidays off became normalized, and nobody is virtue signaling anymore that they worked the whole weekend, even if they did. People take their vacations.Now that doesn’t mean the hours of hourly workers, healthcare workers, construction workers, service and restaurant industry workers, etc, are getting shorter, but as I said, that is more a social equality problem than anything about the economy or inflation rate specifically.
Okay you’re basically right that effective necessary (so discounting bullshit) white collar working hours are declining, but also you should really read the book I linked. It expands on what you said here on multiple levels, and I suspect you’ll find it somewhere between interesting and enlightening.
The spending itself isn’t the benefit, it’s what that spending entails. When you purchase something new, whoever made it is now likely to make more. When you feel that you’re better off just not having the thing, less labor happens.
Don’t hoard cash, spend it on things with a return > 3% and you’ll be fine
In addition to incentivising spending, there’s also the fact that you cannot perfectly control inflation. Even if you target an inflation of 0%, it might still go above or below that. But below 0 is only deflation and once you get there, you risk going into a deflationary spiral. So it’s a safety buffer as well.
https://en.wikipedia.org/wiki/Inflation
Today, most economists favour a low and steady rate of inflation. Low (as opposed to zero or negative) inflation reduces the likelihood of economic recessions by enabling the labor market to adjust more quickly and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy, while also avoiding the costs associated with high inflation.[17]
All the economic recessions in recent history show just how most economists are full of bullshit.
Rephrasing: People wouldn’t want to spend money and stop working
So, ideally it should be something like 0.001% and remain steady.
Central banks don’t control inflation that directly or precisely. 2% is viewed as a low number that’s safe to target in the event that they undershoot.
Deflation is considered a much bigger potential threat, so having that small of a buffer would be risky.
You can’t look at the inflation rate in isolation and decide if that’s good for you or not.
If inflation is 0.0001% and you are laid off and there are no jobs and the stores have empty shelves not that you have any money to buy anything, that’s a bad economy.
If inflation is 3% but there are plenty of jobs and you get a 5% raise every year, that’s a good economy.
