inflation

Inflation

(Topics: The Economy | Back to Home)

Something happens when you become an adult. You realize that stuff is more expensive than it used to be.

This is an economic concept called inflation, and it's something we all have to know about. Inflation means that the total size of the economy is getting bigger faster than our ability to keep up. So we have to spend more money on the same purchases.

Think of the economy as an enormous factory that we're all trying to run around to keep up with. If we can't keep up, the economy is inflating. If we're waiting around on the factory for stuff to do, the economy is deflating.

Deflation is a bad time for everyone, so to keep us safe the government tries to nudge the factory so we have a very low, very predictable rate of inflation of around 2% [1].

Inflation also encourages people to participate in the economy. You could withdraw your paycheck in cash and put some in your mattress every month. But if you did that for 50 years, the money you saved wouldn't be worth much. Instead, the economy works if we're all investing in it through buying and selling.

Especially if we have a good mix of short-term purchases (such as lunch) and long-term purchases (such as mutual funds.)

Keeping the inflation rate under control is an essential function of government because only the government can control monetary policy. And no entity but the government has power to cause damage to the country through accidental policies that cause runaway inflation (or deflation.)

Misinformation about Inflation (Misinfoflation?)

There are lots of examples of times and places where inflation got out of hand, and people want to blame U.S. political parties that have nothing to do with anything.

So yes, there was runaway inflation in Germany, Zimbabwe, Venezuela, Brazil, Hungary, and other places. But each of these situations is different and was resolved in different ways (some better than others.) So it's not reasonable to warn that the U.S. could become one of them, because they are all quite different and none of those countries is very similar to America in the 21st century.

That being said, what is possible (and even being proven out) is not hyperinflation (like 200% in some places [2] but consistently high inflation (which we have today in the 5-10% rate) [3].

Government Policy That Will Help

How can the government reduce inflation? Three things stand out (all of which are variations on a theme)

1. Raise the federal funds interest rate. This is how much it costs for banks to lend money to each other under the rules controlled by the Federal Reserve. The more expensive it is for banks to borrow money, the more likely people and businesses are to save money rather than borrow and spend.

1. Decrease government spending. The less money the government spends, the less demand there is for the many things the government buys—which is a lot of the same stuff all of us buy, from furniture to gasoline to computers. And if there is less demand prices will fall (or rise less quickly) accordingly.

1. Promote and support a reduction in aggregate demand. That's a lot of words to explain that if we buy fewer things and spend less money as a country, prices will go down (or at least not raise as quickly.) This is hard to do because it's a million small little policies that add up [4].

If you haven't caught it yet, the way to reduce inflation is to cool off the economy for everyone—-people, organizations, and the government—to spend less money.

The hard part is actually doing it.


[1] https://www.clevelandfed.org/en/our-research/center-for-inflation-research/inflation-101/why-does-the-fed-care-get-technical.aspx

[2] https://www.statista.com/statistics/371895/inflation-rate-in-venezuela/

[3] https://www.usinflationcalculator.com/inflation/current-inflation-rates/

[4] Some examples just relating to cars: if more of us work from home or we have shorter work weeks, we will use less gas when commuting. Do this enough and the price of gas will fall (or not go up as much.) Or if we all inflate our tires it can improve our gas mileage. Or if carpool/combine trips more. And government can encourage these behaviors through incentives or PR campaigns. By themselves these won't do much. But all together it can have an impact.

inflation.txt · Last modified: 2024/03/28 18:16 by rslaughter