What causes inflation?

[Rich_by_the_Bay]

Why do we have inflation?

Not talking about gas going up because of mideast troubles. I mean in general: is it a necessary product of growth? Is it government printing too much money?

 

[audreyh1]

The standard answer is:

Too much money chasing too few goods.

If goods becomes scarce - you have inflation.
If money becomes plentiful - you have inflation.

In both cases, buyers bid up prices.

So - yes the government can cause inflation by printing too much money. You can argue that the recent boom in home prices was due to too easy money (credit). But inflation can also be caused by goods becoming more scarce - like oil for example.

Audrey

 

[greg]

Rich: Here's a longer version for the weekend.

http://en.wikipedia.org/wiki/Inflation

It's always interesting to look at things if there was no inflation. If wages and material prices were static in the building of cars for example, then as productivity increased, the ability to build new cars at say the rate of 10/day/person instead of 5/day/person, cars would actually get cheaper relative to wages. Wages would stay the same, but goods would keep going down in price, tracing or following the increases in productivity. This would be especially nice for retired folks who had already accumulated their money . But workers like ever increasing wages to buy more goodies.

So we chose, or had chosen for us, the second option. It is generally agreed by Keynesian economists, at least, that a bit of inflation greases the wheels, about 2% is the agreed upon figure. More is bad, and less is bad as they see it.

Good Luck. This is a fun one . Austrian economics, Ludwig Von Mises, is an interesting (and to my mind) alternative economic theory. Google it

--Greg

 

[Rich_by_the_Bay]

Rich: Here's a longer version for the weekend. ...
So we chose, or had chosen for us, the second option. It is generally agreed by Keynesian economists, at least, that a bit of inflation greases the wheels, about 2% is the agreed upon figure. More is bad, and less is bad as they see it.

Good Luck. This is a fun one . Austrian economics, Ludwig Von Mises, is an interesting (and to my mind) alternative economic theory. Google it

Cool! 8)

 

[mathjak107]

inflation is the effect of what happens when prices rise either because of material shortages or printing of more money...as an example oil causes goods to rise in price ,eventually it trickles thru and all goods start to rise..workers cant make due with their pay and require wage increases...prices rise again to cover the wage increases ...the spiral starts from here...theres a lot more to it but this simplifies it i hope

 

[cute fuzzy bunny]

Theres also 'invisible inflation'. Getting less for the same price.

Customer service being cut back to the point where you have to spend hours to resolve a problem, get something fixed or replaced. Shrinking product sizes. Smaller portions. "Extras" that used to be free costing extra.

I think there was a lot of "slack" in the system and over the last 5-6 years a lot of "cost cutting" has produced a good bit of 'invisible inflation'. Theres an end to that though...you can only cut so much. I wonder what happens when you reach that point...

 

[samclem]

Air travel in the US is another example of a service getting shoddier as a result of price pressure. The sweltering, jam-packed "T" terminal at Charlotte DouglassIntl after a typical day of delayed flights and cascading effects has all the ambiance of a Greyhound bus teminal (but fewer colorful characters).

Would I prefer re-regulation and tickets at twice the price? Nope. But the system sure ain't pretty.

 

[Rich_by_the_Bay]

The standard answer is:
Too much money chasing too few goods.
If goods becomes scarce - you have inflation.
If money becomes plentiful - you have inflation.

Hmm. So what would happen if their was a finite amount of money in circulation, and a free market. It would be a zero-sum game. Would the best value product always win? Would unemployment result and spread, thereby bringing downward pressure on prices? Is there any historic precedent?

Wish I'd taken economics 101 in college. I'll put it on my list of things to do in ER!

 

[cute fuzzy bunny]

Conditions like that existed in some areas at some times, such as in the US in the late 1800's and early 1900's. Frequently, deflation was a result.

 

[d]

a finite amount of money in circulation....

the amount is finite ... if it were infinite, inflation would be astronomical and the money would be of no value.

In part, and overy simplistic, the level of economic activity is a function of the money supply, so that if the money supply grows too slowly, GDP grows less than potential (could contract) resulting in increased unemployment and disinflation. If the money supply grows too fast, increased inflation results.

 

[samclem]

I think, reading in context, that Rich probably meant "fixed" vice "finite."

 

[mathjak107]

well im looking at a chart that shows what people do in times of higher inflation..the number of people going to the movies seems to go higher the higher the inflation rate ......
maybe i stumbled on to the real cause of inflation....GOING TO THE MOVIES CAUSES INFLATION

 

[audreyh1]

Hmm. So what would happen if their was a finite amount of money in circulation, and a free market. It would be a zero-sum game. Would the best value product always win? Would unemployment result and spread, thereby bringing downward pressure on prices? Is there any historic precedent?

Well, that's why the government prefers at least a 2% inflation rate. There is economic growth. It seems to be a more "comfortable" environment for business and workers to operate. Less than 2% and you have "disinflation" and concerns about a slowing economy. The Fed was starting to get very worried about this scenario unfolding in 2003 - that's why the interest rates went so low.

Deflation is very bad news economically (witness Japan recently) and the Great Depression. Businesses suffer, unemployment rises. So it's preferable to have some inflation - just very low.

It's really walking a tightrope!!

(OK - that's about the limit of my economic knowledge - never studied it formally).

Audrey

 

[Nords]

Well, that's why the government prefers at least a 2% inflation rate.

Or maybe the CPI is only accurately measured within 3%...

 

[greg]

Rich: A moderate amount of inflation also tilts the playing field toward consumerism. If you buy a product now, it is cheaper than later. If you buy it on time payments, borrowing the initial money, you pay it off slowly with your expected higher wages. Has any middle-age or younger person ever purchased a house and thought "Gee, I'll probably be making LESS money in the future, so this mortgage will be harder to pay off with my future wages." Inflation creates a 'get it now' attitude in its citizens over time.

When this sort of thing gets out of balance, gov'ts try to rectify it. Japan printed money and tried to create inflation so that more of their citizens would consume more now. They have always liked to save a high proportion of their money. We in this country have a problem on the other end of the continum. We spend more than we make in wages, more money than we produce as a country. Unless you count the recent housing bubble, where 'easily' borrowed money was introduced into the system, where an engineered sort of fake wealth was created. If you count it as real wealth, then things appear balanced.

Of course, business interests see inflation as a good thing. Deflation would mean that if you saved a $ it would be worth more when you went to spend it, say in retirement. Now, when you save money, you also need a mandatory interest rate (see TIPs) just to stay even. Gov'ts also like the extra tax money that inflation provides. Things get real mucked up with inflation swirling around the environment.

--Greg

 

[macdaddy]

"So - yes the government can cause inflation by printing too much money. You can argue that the recent boom in home prices was due to too easy money (credit)."

In fact these are the same thing. By increasing credit, you have effectively added money to the system. You may have heard of "B52" or "Helicopter" Ben Bernanke, the new Fed Reserve Chair's nickname, which comes from a paper where he debated the different ways that the Fed could distribute money to people. You can print more money - sure, easy to do - but where do you put it, in order to add liquidity to the system, which is the intention? If the Fed lowers the rates for loans, they have effectively created some money, because the payments for the same amounts of money are lower. A more effective way to flood the system with liquidity is for the Fed to print money and then purchase mortgages, redeemed treasury notes, etc. In his paper, Bernanke suggested filling up helicopters with money and simply dropping it over cities for people to pick up. I think inflation will start to pick up in a couple years and we will be in for a wild ride.

 

[Rich_by_the_Bay]

If you buy a product now, it is cheaper than later. If you buy it on time payments, borrowing the initial money, you pay it off slowly with your expected higher wages. Has any middle-age or younger person ever purchased a house and thought "Gee, I'll probably be making LESS money in the future, so this mortgage will be harder to pay off with my future wages."

This has been really interesting.

It feels like in some ways it's credit that causes inflation, or at least contributes to it. In order to loan money, you must be able to collect interest on the loan. That sets the whole cycle going: you have to borrow money to buy a house (or a business does to buy assets), and thus you have to pay off the loan. So $1000 today has be worth $1050 at some time in the future in order to allow loans to be made. On the other end, you have to increase your business profit by that amount (i.e. charge more) just to service your loans, etc.

 

[wabmester]

Japan printed money and tried to create inflation so that more of their citizens would consume more now.

You're right about Japan intentionally creating inflation, but I don't know if consumerism is what they were trying to drive.     I don't know any consumers who say "OMG!   Jennifer, take a look at that inflation rate -- let's go to the mall and stock up!"

Lowering interest rates is supposed to help on the supply side and reduce unemployment.    The idea is that *businesses* see the very attractive low interest rates, so they increase their borrowing, capital investment, and hiring.    The fed uses the montetary printing press to try to create a balance between inflation and unemployment.

As has already been mentioned, when the fed is constrained from doing this (e.g., when our currency was gold-backed), the result can be deflation and run-away unemployment.

 

[audreyh1]

"So - yes the government can cause inflation by printing too much money.  You can argue that the recent boom in home prices was due to too easy money (credit)."

In fact these are the same thing. 

Yes exactly - I was giving that as an example of the government "printing too much money" - but I meant increasing the money supply, which seems to be the same difference.

 

[califdreamer]

A couple of glasses of wine takes me back to Finance 101 and learning about the Fed and money supply. Hope I can keep this straight.

In essence, the money supply is created by lenders. Lenders are able to lend out money to bizzes and individs as long as the lenders keep a required percentage of the money they lend out in reserve. The Fed can change this reserve ratio but they don't do it often (don't have any clue when the last time they adjusted this) because it is such a blunt instrument... sort of like killing an ant with a sledge hammer. Instead the Fed tinkers with the Fed funds rate, the short term rate we hear about in the news. It's the rate that banks charge each other for short term (literally overnight, I believe) loans. The bond market then determines the longer term rates which effect mortgages, etc.

So it makes sense that if the Fed raises the Fed funds rate and the banks react by raising their prime rate and the other long term rates fall into line (it doesn't always happen so neatly as we've seen recently) borrowers will borrow less, that will slow down building plant & equipment, hiring, etc.

The money supply then is only indirectly determined by the Fed in this case.

I believe the Fed also buys and sells bonds and notes on the open market to effect money supply. I may have this turned around, but if they sell bonds and notes they would essentially be pulling money out of circulation thus diminishing the money supply. When they buy bonds and notes they increase the money supply.

So the gov't doesn't literally "print more money", they put into motion policies to effect the market to expand or contract money supply.

Others may have refinements and/or corrections which I, for my own understanding, welcome wholeheartedly.

 

[bpp]

Has any middle-age or younger person ever purchased a house and thought "Gee, I'll probably be making LESS money in the future, so this mortgage will be harder to pay off with my future wages."

I have, sort of. I expect my wages to be stagnant to slightly decreasing for the foreseeable future, as they have been for the past few years. Would have bought a house with cash if I could have, but I couldn't, so took out a mortgage.

Bpp

 

[d]

the gov't doesn't literally "print more money", they put into motion policies to effect the market to expand or contract money supply.

Thank you!  Every time I've read "print money" I've wanted to scream.

 

[Martha]

Thank you! Every time I've read "print money" I've wanted to scream.

I feel the same way. Really, it doesn't fall out of helicopters.

The primary work I do these days (on the rare day I work) is representing lenders who finance fairly large commercial projects. With the rise in interest rates it is amazing how fast the commercial lending business slows down.

 

[camberiu]

Thank you! Every time I've read "print money" I've wanted to scream.

For all practical purposes, it is the same damn thing. And the gold has just hit $607 on the spot market and the dolar is falling like a brick on the Asian markets as I write this.

 

[d]

For all practical purposes, it is the same damn thing.  And the gold has just hit $607 on the spot market and the dolar is falling like a brick on the Asian markets as I write this.

1) it is not at all the "same damn thing" ... when banks loan money there is an asset increase and an offsetting liability inrease ... when little green men "print money" there is no change in liabilities.
2)... just another 40% or so and it will be back to a more than quarter century high.