Reaction & Commentary
Ten thousand dollars are all the result of inflation the idea that over time money becomes worth less and less influences a lot of the decisions in our lives everything from retirement planning to salary negotiations take this relatively benign and constant force into account but is it something that should be feared
Hyperinflation is where this slow but steady force explodes and renders money all but useless you have no doubt seen images of people in zimbabwe venezuela or the weinman republic wheeling in trillions of dollars in bills to pay for groceries and in many ways this is seen as pretty much
Game over for any economy that experiences it there are only so many zeros you can add to your banknotes before nobody takes them seriously anymore and as soon as people no longer respect a currency that currency is useless now in all of these past examples hyperinflation was caused by an unstable
Economy that the government desperately tried to mend with huge stimuluses funded by printing lots and lots of money for those of you who have not made the connection the us and dozens of other nations around the world in the last few months have been trying desperately to mend their unstable economies
With stimulus packages funded by printing trillions of dollars since the money printers fired up in early 2020 the us has added over three trillion dollars to its m2 money supply that’s more than a 20 increase in the total amount of money washing around in the economy
In the space of around six months what’s more is that three trillion dollars is coming close to doubling the amount of cash in active circulation that’s the pool of cash which is actively out there being spent on goods and services rather than sitting dormant in a bank account or term deposits
When you consider that hyperinflation is classed as a 50 increase in general prices per month it is reasonable to expect that this printing bonanza may be starting to push into dangerous territories or is it is hyperinflation actually something to be concerned about in developed nations like the usa
Or are all of these cautionary tales just a ploy to try and get people to buy gold coins at 50 over their base value well to properly answer this we need to of course look at a few key details and answer a few key questions what actually is inflation it’s weirder
Than you might think is inflation actually good or bad for the economy is the money printer causing inflation right now and what are the best ways to protect against this harsh reality this episode of economics explained is brought to you by you the viewer if you’d like to help make
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Want to miss it definitely check it out but without further ado let’s get into today’s video now inflation always seems to have a negative connotation when people are talking about it but amongst economists there are some pretty significant difference of opinions these range from it being a necessary
Evil to a driver of our economic demise but to understand either side of this debate we must first understand what this phenomenon actually is so what is inflation inflation is the rising price level of goods and services within an economy i wouldn’t be surprised if a good chunk
Of you watching were uttering this under your breath as if it were so obvious but here’s the thing while this definition is technically correct it misses a lot of detail the first part where this definition is a bit vague is the definition of goods and services what are these goods and services well
That’s simple right it’s a selection of goods and services that are indicative of a standard household budget all bundled up in what’s called the consumer price index the consumer price index is created by monitoring household expenditures and then looking at where that money is going now again
This probably isn’t a huge surprise to people watching an economics video but where this gets a bit weird is the methodology used to actually measure these figures most developed economies will delegate a national government department to watch these statistics in the us for example it’s the u.s bureau of labor statistics
What they will do is monitor a few thousand homes in urban areas across the nation to get a baseline on what a set basket of goods will cost and this is not yet actually considered the consumer price index but rather it is the household expenditure survey this causes one initial problem which is
Basically schrodinger’s consumer price index you can’t effectively measure something without changing the result if a government agency is checking through your household’s receipts you’re almost definitely going to change your spending this isn’t just big picture stuff either like a little less money spent at cj entertainment but also more mundane things
Just the idea that someone is reviewing your expenses will mean that you are thinking about the money that you are spending which is more than what most people do in any given month because of this household expenditure will trend downwards as people try to present a more fiscally conservative image of themselves
This can be really bad because the time series of these expenditure measures is what goes on to form the consumer price index so government agencies could be working with pre-skewed figures now schrodinger’s cpi measure is actually a relatively minor issue that most agencies are aware of and account for
But there is a more serious problem caused by a different type of government interference sales taxes and subsidies impact the consumer price index this isn’t so much of a big deal during normal economic conditions but sweeping government reforms can make these figures very blurry in response to the economic downturn
Caused by the coronavirus the australian government introduced a stimulus package that would pay for child care in an attempt to get younger workers to work this saw a 95 reduction in household expenditure on child care the remaining 5 being made up of people that paid for personal nannies now
Child care in australia and most developed nations for that matter is expensive and it takes up a good chunk of regular households budgets so completely eliminating this category will have some pretty serious impacts on these figures the opposite is also true with taxes things like carbon taxes sales taxes liquor taxes or
Anything else that impacts the price of a good directly is subject to a discretionary change by the government for example if a nation implemented a 5 blanket sales or value-added tax it would look like inflation has spiked by 5 and in many ways it sort of has inflation measures the rising price
Level of goods and services taxes increase these price levels but it does mean that governments can kind of tinker with the results by properly using these subsidies or taxes now if this is accounted for it’s just fine but if not it can cause a vicious feedback loop of policies causing inflation
To deal with the policies that are causing inflation but all of this being said there is a reason why understanding these limitations is so important it helps us properly understand the mechanics behind what inflation actually is beyond the rising price level of goods and services in the economy
This understanding means that we can properly ask is inflation good or bad it sounds like a really silly question because of course inflation is bad right things costing more and savings been worth less how could that possibly be a good thing this seems logical enough but there are
Actually some very good reasons behind why most developed governments actually target a 1 to 3 inflation rate inflation is bad and the opposite deflation is also bad but deflation is worse deflation is when the prices of goods fall over time so this might actually seem like a good thing
But it causes some serious concerns the first is that it reduces consumption if things are becoming cheaper and cheaper every year people will be more inclined to save cash and buy something superior later on why buy a toyota camry this year if that same money could buy a bmw next year
Now this particular argument is actually disputed by a lot of economists that will note delayed gratification is still beneficial in today’s economies but one look at the world of easy finance and buy now pay later will show you that people might not actually plan this far ahead what
Is a more direct consequence of deflation is the impact that it has on debt for example if you have a one hundred thousand dollar home loan at a three percent interest rate and the annual deflation rate is two percent what this effectively means is that you are now going to be paying
A five percent real interest rate because every year your repayments become worth more and more this hurts households with debt and means that people will seriously consider holding off on debt fuel purchases which can stifle a lot of markets everything from buying a new outfit with a credit card to
Starting a business with a bank loan will come with a little bit more of a pause for thought deflation also has a strange relationship with employment and wages if cash is going to become more and more valuable every year then a 50 000 salary will be the equivalent of a
51 000 salary in 12 months time this will likely mean that businesses are a lot less generous with nominal pay rises and a lot less generous with initial salary offers if you throw in complications like a set minimum wage on top of this it can become really murky the idea of a
15 minimum wage is a big deal in american politics at the moment and this would probably do a lot of good for the economy as a whole but if deflation was a reality we may see one of two things happen one is that the minimum wage level would have to fall every year
Which is probably going to be very politically unpopular or the second option is that businesses just won’t be able to afford as many workers in lower margin roles this effect is called real wage unemployment and was a serious problem for japan during the 1990s during a prolonged period of low inflation
The one last thing to remember is that goods getting cheaper and cheaper doesn’t mean very much for the average household if wages are shrinking along with them and there is a psychological component to seeing bigger salary figures over a working career that drives people to boost their lifestyle for all of these reasons
Most economists agree that inflation is better than deflation in moderation that’s why most economies and central banks target that one to three percent annual inflation rate so now that we have an ideal target what is actually done to achieve this goal what can governments do to keep inflation steady
And could this record stimulus be printing us off cause there is an unwritten rule in economics that anytime one thing is changed at least two other things change along with it there is actually no direct tool that governments have to control inflation outside of becoming a complete command economy that sets the price
Level of everyone’s beat rations although there are tools that impact inflation as one of its side effects the first is fiscal policy fiscal policy is just a fancy way of saying government spending and government taxation the primary motivation behind these policies is to provide public goods things like roads schools emergency
Services and all that good stuff but another key motivator is economic growth the politicians and their advisors that dictate fiscal policy want their economies to become richer so that they can get re-elected therefore a lot of thought is put into how changes in taxes and spending will impact things like employment and
Business growth fiscal policy can also be used as an emergency safety measure to keep the economy afloat during times of crisis like printing three trillion dollars to fund stimulus checks unemployment benefits and corporate bailouts the second tool that governments have to influence inflation is monetary policy which is again just a
Convoluted way of saying the raising and lowering of interest rates officially this is handled by the central bank which is technically an independent agency but for the sake of simplicity we will just say that fiscal and monetary policy are conducted in unison now both of these policies
Influence four main things that in turn impact inflation these things are industrial output employment the money supply and the velocity of money industrial output is the first big one if government spending can be put towards making an economy more efficient it will be able to produce more output things like
Good roads shipping ports internet infrastructure can all massively increase how many goods and services can be produced within a nation being able to produce more stuff means that there will be more supply which will actually decrease prices but the opposite is also true if for example
All of the businesses in a country are forced to close down or massively limit operations that means there will be less output which means less supply and naturally higher prices this is called cost push inflation and it’s the worst type of inflation because it generally means the economy is just becoming poorer
And desperate consumers are having to spend a larger portion of their paychecks on an insufficient supply of essentials unfortunately monetary policy can’t do anything about this and short term even fiscal policy can be limited but the best way to avoid cost push inflation long term is to make sure the economy is investing
Into infrastructure that makes every worker more efficient and more productive speaking of workers employment is actually an important factor in fending off hyperinflation as well because believe it or not too much employment can be a really bad thing we’re used to hearing about politicians promising more jobs but if unemployment falls too low
It can almost be as bad as if it spikes too high imagine a world with zero percent unemployment anybody who wants a job has a job sounds great right well imagine if in that same world an enterprising young entrepreneur wanted to start a new business
They can put out a hiring ad on job boards but they are going to find it really hard to find applicants their only options would be to attract workers into joining the workforce or more realistically poach existing employees off another business with either option they’re going to have
To make it worth that employees while with a pretty generous pay package nobody is going to leave their job to join a new business unless they are getting a generous pay increase what’s more is that the business of this worker leaves is also going to have an empty
Position that needs to be filled and again they’re going to have to offer more money to attract a worker from yet another company which is going to need to fill that position and on and on until wages become extremely high extremely high wages are great when they are the result of huge worker
Output but when they are the result of a lack of supply in the labor market it’s bad because many businesses just won’t be able to operate without charging a lot more for their products to cover the salary cost which is inflation there is actually a benchmark in economics called the
Non-accelerating inflation rate of unemployment what this rate is differs from economy to economy but in a modern developed nation as soon as unemployment starts dip below two percent inflation becomes a real issue fortunately or perhaps unfortunately the opposite is also true a high rate of unemployment
Like the massive spike in people out of work we have seen in recent months has a deflationary impact on the economy because people are willing to take any job regardless of the pay and people out of work won’t have as much disposable income to spend
So shops will be forced to run sales to attract what little consumer demand still exists now the third variable is the money supply money supply is probably the hot topic issue at hand because of course it has been massively increased as the money printer has gone bro
If there is more money washing around in the economy and that economy is producing less stuff because well all the businesses have been forced to close then naturally that money is going to have less relative value this is called demand a pull inflation because more people have more money in their wallets and
They effectively pull prices upwards this can actually cause a scary phenomenon known as stagflation where unemployment and real growth is low but inflation is still rising fortunately for now at least it doesn’t look like this will be an issue and the reason for that is because of the fourth variable
The velocity of money the federal reserve could theoretically print 100 trillion dollars overnight and it would do very little to the price level of things if that money wasn’t actually out there being spent the velocity of money is a measure that economists use to show how quickly money
Is changing hands now money changes hands quickest in lower income households if you give a low income household twelve hundred dollars they’re going to use that money up very quickly maybe buying some extra groceries or getting their car fixed or whatever it may be either way that money
Is out there to be spent again and again and again if you give that twelve hundred dollars to a multi-millionaire they probably won’t even bother cashing the check because that twelve hundred dollars is worth less to them than the time it takes to walk that check down to the bank
Even if the household of the multi-millionaire did spend this money it is probably more likely to go towards things like shares bonds or term deposits all things that are not part of the consumer price index and do not count towards inflation so now that we understand the four main
Contributors to inflation and how we can influence them let’s properly assess what the money printer is going to do industrial output has slowed particularly in areas like tourism and hospitality but consumer demand has fallen along with these declines so overall the impact on inflation has been pretty neutral employment has of course dropped
Significantly and more pessimistic workers with less confidence about their careers futures are also spending money less rapidly so the velocity of money has fallen too overall having a downward pressure on inflation especially in non-essential items and finally the money supply well there is no getting around it introducing this much money this quickly
To the economy has had an upwards pressure on inflation but at least in most sectors especially those covered in the consumer price index it has been more than counteracted by the downward pressures of employment and the velocity of money what’s really interesting is that you can actually go to your own government’s website
And find a detailed breakdown of these changes in price levels lo and behold they tell a pretty similar story to the one that we have explored here of course there are things to spend money on that are not captured in the consumer price index and there is a very real chance we are
Experiencing heavy inflation in these areas hmm so are we free and clear of hyperinflation and or stagflation no not by a long shot right now the downward pressures are counteracting the upward pressures and we are in a fragile equilibrium governments around the world have done what they needed to do
To keep their nations afloat but we have to pay for this eventually we are either going to pay for this through taxation or inflation one disproportionately impacts higher income earners and one impacts everyone so perhaps the pessimist amongst you watching might be able to speculate about what the more likely outcome is
All we can do in the meantime is hope that this future is managed carefully and make sure that we plan around this new reality where inflation is going to be more present more severe and more influential a special thank you once again to our incredible patreon community
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