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Monday, 2 May 2011
What is Inflation

The first thing we think of when someone mentions inflation is increased prices. However, increased prices are a result of inflation, not the cause. Rather, the best definition of inflation is too much money chasing too few goods. Or to clarify how this works, on any given day there is some number of dollars in the monetary system. On that same day there are a set amount of goods and services available for those dollars to purchase. Monetizing is the process used by the government, through the Fed, that causes an excess of dollars in the system. When people have extra money, they bid up prices for goods. In other words, if the number of dollars is increased without a corresponding increase in the amount of goods and services available (or a corresponding increase in real value), then all that has occurred is that there are more dollars chasing the same number of goods and services. THAT is Inflation. Your money will buy less! The result of inflation is increased prices.

For example, do you believe prices are increasing? In the 1950s, you could buy a week's worth of groceries for $10, a car for $1000, a pack of cigarettes for $0.20 and a gallon of gasoline for $0.25. A stay in a hotel was $2 a night and a hospital stay was $15/day. The dollar today has a fraction of the purchasing power it once had. Those increased prices are a result of inflation.

Neither inflation nor deflation* are good for an economy. Both generate uncertainty which causes people to hold off on investment and purchasing decisions because they cannot predict what will happen to their investment. Most economists feel a slow steady rate of inflation is the preferred course. This is because deflation is harder to manage since while decreased prices are acceptable, wages are fairly inelastic in a downward direction, so rather than take that risk, they feel a little inflation is the better course. In our opinion, no inflation or deflation would be the preferred choice and with a better monetary system, we believe it is achievable.

* Deflation here is used in the sense of value being lost in the economy. Deflation is beneficial when considered as the natural decline in the prices of goods as they become less expensive to manufacture through productivity increases.
** Wages being inelastic means that, even though as prices decrease and purchasing power increases, employers cannot easily lower employee wages. What is more likely is that the employer's business fails because a more competitive business opens down the street paying employees lower wages. They can do this because the lower amount will be adequate since prices of goods and services are lower. The overall economy suffers as displaced workers must find new employment. Deflation in the 1930s was devastating.

Posted on 05/02/2011 11:22 AM by Jack Massari
21 Mar 2013
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