Inflation: The Basics

It would appear that there is some disagreement here at EvC on the nature of inflation. While, in my opinion, this disagreement is about as justified as that between a YEC and a geologist regarding the age of the Earth, it exists nonetheless and so it is probably worth addressing.So far, this disagreement has been derailing a thread started most recently by Phat: Social Unrest?. It started when DBlevins posted the following reply to my statement that paying more for less labor was a championing of 'inflation and economic failure' (Message 10), triggering a volley with myself and Damouse:

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DBlevins in Message 25:

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Everyone 'champions' inflation. No economist champions deflation.

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Damouse made a reply representative of the position of those opposing this view:

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Damouse in Message 63:

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Inflation is not good. Inflation is loss of stability of a monetary system.

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By definition, the rise in price gained by inflation on assets and investments is NOT an increase in value, under ANY shape or form. Inflation devalues money, which increases the number next to your asset, but it doesnt make more or better asset for you.

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To go with this, I gave an example of a non-inflated vs. inflated economy that I think is important-enough to repost here, as it lays out the differences pretty simplistically:

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Jon in Message 70:

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We have an economy: E. Remember, an economy is just a group of folk who trade things. To make their trading easier, they invented money: . Remember, money is just an easy-to-use Standard of Scale that lets folk understand the value of many different things in terms of only one thing. To simplify this example, we focus on only one good in this economy: G. Oh, and people: F.

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Economy: E
Money:
Widgets: G
Folk: F

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Goods are hot items, and everyone wants them; folk will buy Goods so long as they have money for them.

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So, we set up our economy. We have:

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10F
1000G
10,000

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The 10,000 is spread equally over the 10F (100 to each), who, of course, use ALL of it to buy up the 1000G. The price per good: /G = 10,000/1000G = 10/G. We can figure out the REAL VALUE of by comparing it to the # of G that can be bought with it. Since each G costs 10, the value of is calculated as G/ = 1G/10 = 0.10G/, which only tells us that because it costs 10/G, each can only buy 1/10 a G. The REAL VALUE of (as measured in an actual, REAL, goods, G) is 0.10G.

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Behold! A second, almost identical economy: E2!

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This economy is almost exactly the same, except:

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10F
1000G
20,000

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As before, all of is divided over the 10F (200 to each this time), who, as before, use ALL of it to buy up the 1000G. This time, the price per good: /G = 20,000/1000G = 20/G. We can figure out the REAL VALUE of by comparing it to the # of G that can be bought with it. Since each G costs 20, the value of is calculated as G/ = 1G/20 = 0.05G/, which tells us that because it costs 20/G, each can only buy 1/20 a G. The REAL VALUE of (as measured in actual, REAL, goods, G) is 0.05G.

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Now enter Mr. MoneyBags. He wasn't bright enough to convert all his money () to goods (G), so he only has money. In which economy is his money () worth more? In which economy does his money () have more REAL VALUE? Is this the economy that represents Inflation (where the price/good is higher), or the one that does not represent Inflation (lower price/good)?

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In the real world, Mr. MoneyBags is a low-income man on a fixed budget; he doesn't have any goods he can sell, only a fixed income; when the price per goods goes up, the value of his money goes down. Poor Mr. MoneyBags... poor average citizen in an inflation.

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crashfrog has also joined the debate, though, like Damouse, I am inclined to think he is just playing around:

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crashfrog in Message 75:

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More people can have more money and choose to save it, and there is no inflation.

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This is the only thing you're right about. And why is that? Why is it that the government could give everyone a thousand dollars to bury in their backyard and it wouldn't drive up the price of anything but shovels?

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Because inflation is caused by more money chasing the same amount of goods and services. The prices of goods and services are driven up as a result. It's supply and demand. You remember supply and demand, right? When demand increased but supply does not, the prices go up. That's the cause of inflation - more money chasing the same amount of goods and services.

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But that's a good thing. More demand for goods and services puts more people in the business of providing goods and services. Any goods or services that people already have increase in price.

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The primary arguments, then, appear to be:1) Inflation is bad:
a. Inflation decreases the real value of money, and this is bad because anyone today holding money from yesterday has something with less value.2) Inflation is good:
a. Inflation increases the price of goods, and this is indicative of an increase in the value of those goods.
b. Inflation is a representation of an increase in demand, which drives up production and economic growth.Thus, there is some clear disagreement on even the most fundamental aspects of inflation; even the basics cannot be agreed upon.So, let's have a little chat about the basics of inflation.JonEdited by Jon, : -ve +s

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First, let me quote the message in its entirety for sake of having everything in one thread:

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DBlevins in Message 79 of Social Unrest?:

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To ease congestion I thought I would combine my response to Jon.

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Post 74

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I assumed this was the case when I replied to you earlier. You never addressed the issue.

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I never addressed the issue because I never said I was talking about during the war, but afterward. Your question didn't seem relevant to my statement about the economy, unless you could be more clear about why you bring up the economy during the war versus the economy after.

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Certainly wasn't money spent on condoms...

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Flippant but perhaps I deserved that. M increased, but what happened to the economy?

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No, they COST more; their VALUE does not change.

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Jeebus. I'm not sure if we are talking around each other or you are purposely being obtuse.

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Do the checks increase or decrease the amount of money in circulation? In our example, does it move us from E1 to E2, or from E2 to E1?

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It depends on what they do with it, wouldn't you say .

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Let's get back to the real world. We expect that if the economy is working properly, an increase in monetary supply will cause inflation, but it will also likely cause an increase in productivity, which has the effect of eventually suppressing inflationary pressures. Of course any large shock due to pricing caused by supply and demand pressures or any shock induced by monetary policies can induce either hyperinflation (bad) or stagflation (bad) but if everything works and there are no shocks then most economists would agree that having that little bit of inflation is a good thing.

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Small condolence, since the money left over is now worth less than yesterday.

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Not if your purchasing power has not been significantly affected, which would be the case when productivity has increased. You're telling me that you would rather pay 6% interest on your house than you would 4%?

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Now on to post 78

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It is less.

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But this is off-topic, really. We should start an inflation thread.

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Not necessarily. While I agree that prima facie it would appear to be the case that my dollars are worth less, that would be the case IF everything else cost more as well. It might even lead to inflation if this happened in significant portions, but this is a one time occurence where the value of the dollar remains the same, it is the subjective value of the pencil that has increased. If you can buy more things because you sold that pencil for more, the dollars value with respect to your purchasing power has basically remained the same.

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Now, I will reply to it: Interestingly, I never made any comments about the economy during the war; Damouse did, though, and perhaps your reply was meant for those comments. My question was:

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Jon in Message 61:

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A return to the prosperity of the post-war and pre-reagan economy.

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Huh? What caused post-war prosperity?

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I had been assuming WWII, but you replied to me by talking about the 90's, and so I thought maybe I had guessed the wrong war. Since we now understand that it was WWII you were talking about, I think a reply to my question is in order. Indeed; but to keep it from having an impact on the amount of money in circulation, we'd have to prevent every single person who receives a check from spending any of that money. This is unlikely, and so these government checks are undoubtedly going to impact the amount of money in circulation. With that cleared up, perhaps now you can answer the question: What is the impact of these government checks on the amount of money in circulation?Productivity where? If my earnings do not increase, then I have the same amount of money; unless you can keep my income rising with inflation, then the overall effect is a decrease in purchasing power. You're not accounting for the affect of the labor pool. No; your dollars are worth less than the dollars of the person who only paid $100 for the same pencil. Value of money is determined by the amount of goods/services it can buy, using a simple equation: Goods/Money. In this case, the $100 has more value than your $135, since less money is used to buy the same good (p = pencil):1p/$100 = 0.010p/$
1p/$135 ≈ 0.007p/$That real value of money is not the number next to the $ sign. It is not the amount of goods/services for which it 'might' be exchanged. It is the amount of goods/services for which it can be and is exchanged. You are using 'value' in two different ways here, which I think is the cause of fault in most of your argument. Can you separate them before we continue?Jon

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Tough. This is exactly what the poor do with almost all of their moneyand they have no choice. The physical assets they do have are not saleable, as their life and/or livelihood is upon them dependent.Most people are poor. The majority of people are negatively affected by inflation.Jon

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Quite correct. Poor people are sitting on small piles of money, the value of which decreases with inflation. Rich people hold their wealth in capitaltangible stuff. So, yes, no big piles of money out there. I know; I separated them because they appeared to be representative of the two 'pro-inflation' arguments being made in the other thread. Each of you, however, had mixed the two parts a little, but I thought it worth mentioning the difference. Depends; are there means to meet that demand? Who will meet that demand? See above; the assumption that an increase in demand is inherently a good thing is quite simplistic and, dare I say, nave.Jon

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If you had read my previous posts, you would have seen that you've taken my 'INFLATION IS BAD' comment out of context. I also said:

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Jon in Message 17:

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When inflation occurs, deflation is the quickest fix.

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Is the system inflated or deflated? If you believe it inflated, then you should adopt my solution above. If you believe it deflated, then an alternate solution is required. If you believe it inflated, but continue charging more and more for the same output each successive day, then the system will fail.

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Before pretending to have a grasp on your opponent's position, you should first bother understanding itin full. Out of work where? Factories where? Demand from whom? Whose labor? There is a problem with your theory; it doesn't account for certain things. Can you spot what those things are? The questions above were designed to help you with that. Value ≠ Money. Is 1 hour of work still worth the same amount of bread?JonEdited by Jon, : Begin Editing...Edited by Jon, : End Editing...Edited by Jon, : No reason given.

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I think instead of replying to my first post on the other thread, which many already did when over there, we could move on to reply to the most recent posts made here in response to the most recent posts from the other thread. It would be better than covering old ground.Jon

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What I meant with this question was: From whom are the demanders demanding? LOL. You said inflation increases demand which fuels job growth, this being the, so far, only mentioned benefit to inflation. I asked you to tell me where those jobs were growing and who was meeting that demand. Why refuse to answer the question? This might be meaningful if it weren't for the fact that it is incorrect. I do not think I ever said they were unrelated. In fact, I've often talked about their relationship. Stop misrepresenting me.Jon

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You will find that I have not made such a confusion. Slowing down inflation will not stop it; only deflation can do that.Remember, the goal of an economic system is stability and growth. Inflation and deflation are breakdowns in that stability. Neither is good.Jon

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Your answers do not demonstrate your understanding of the current reality. When you can answer the questions with names of places, instead of theoretical idealizations, then we can continue. But so long as you continue to respond with the same non-answers, there is no way we can move forward.If, when asked to tell me what countries are in the Western hemisphere, you reply by telling me 'all the ones not in the Eastern one', your answer may be technically correct, but it is utterly meaningless, and certainly doesn't demonstrate your knowledge of anything other than how to speak English. Provide meaningful answers, and we can have a meaningful discussion. Sorry, Crash, but your 'units of length' analogy is just bogus. One such failure: Inches do not inflate or deflate; the number next to the inches representing the distance between my feet and my head cannot increase while my physical height remains the same. The notion that increasing the number next to the $ sign representing the 'value' of my TV actually increases my TV's value is as silly as the notion that erasing the 4 next to the ft. representing your height and writing in 10 actually makes you taller. The fact that you believe it does is, as Damouse pointed out (Message 72 in Social Unrest?), one of the dangers of inflation: the (false) belief by the many that Money = Value; that giving up more money today than yesterday for the same thing means it is more valuable. No; I do not need to believe that two things are equivalent in order to believe that they are related. I also do not need to believe that two things are tied together by necessity in order to believe that they are related. You continue to argue against the position that money and value are not related, when I have never taken this position. It is a classic strawman. You need to address the points I'm making instead of the crappier, more easily-refuted ones you wish I were making.Jon

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As before, you've made no attempt to honestly address the points and questions brought up against your position. This is typical of your behavior at EvC, and I've no interest in becoming involved. There's hardly any point in anyone continuing a discussion with one so unwilling to participate.When ready to address the matter and the topic in a reasonable, civil manner that encourages the understanding of one another's positions, then please let me know and we can continue. If you don't want to, that's fine; we can call it quits and there will be no hard feelings on my end.Enjoy,
Jon

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You cannot be serious...Can you?Edited by Jon, : No reason given.

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Thanks for the great reply! I am wondering, though, if you'd be able to tell us how you see Inflation as fitting in to this overall picture that you've described. I notice one thing that might certainly be relevant: Increasing the amount of money in circulation is the essential cause of inflation. With more money and an equivalent amount of goods and services, the cost of each of those goods and services goes up, and the value of the money (the amount of goods/services for which each unit of money can be exchanged) decreases. This impacts everyone; not just the folk who are throwing more money into circulation, but also the folk who do not have any extras to throw. How do you propose this be balanced?An increase in the number of goods/services may well offset this, so long as there is a demand for the new amount, which cannot be guaranteeda person only eats so much bread. Furthermore, if the demand is being met by outsiderswhich is increasingly the case, will this have the effect of off-setting the inflation of our own currency?Does more money being spent in general really help fix the problems you've brought up?I've my own take on things, of course, but I'm interested in hearing yours! Thanks,
Jon

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