Inflation is something that we more or less take for granted these days. The idea that five dollars a day is not going to be able to buy five dollars worth of stuff in the future and the fact that you used to be able to buy a family home for 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.
Hyperinflation is where this slow but steady force that 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. As soon as people no longer respect a currency that currency is useless.
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 amend their unstable economies with stimulus packages funded by printing trillions of dollars to their m2 money supply
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. This has starting to become a concern even for developed nations like the USA.
To understand hyperinflation, we need to first look into inflation.
Inflation
Inflation can actually be good or bad for the economy.
Although 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.
Inflation is the rising price level of goods and services within an economy
These goods and services consists of 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
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 that will 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.
Government interference such as sales taxes and subsidies impact theconsumer price index. Although this isn't so much of a big deal during normal economic conditions, but in response to the economic downturn caused by the coronavirus governments had introduced stimulus packages
Inflation is bad but deflation is too
Things costing more and savings been worth less when governments target a 1 to 3 inflation rate.
Deflation is also bad. When the prices of goods fall over time so this might actually
seem like a good thing but it causes some serious concerns.
First, 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.
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
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.
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.
That's the reason why most economists agree that inflation is better than deflation when in moderation. Governments try to keep inflation steady and there is a reason to think when this record stimulus may be printing us off course.
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 although there are tools that impact inflation as one of its side effects which is fiscal policy such as government spending and government taxation to provide public goods things like roads schools emergency services and all that good stuff but another key motivator is economic growth.
Fiscal and monetary policies
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 trillions 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
This is handled by the central bank which is technically an independent agency. These policies influence four main things that in turn impact inflation. These things are
Industrial output
Employment
Money supply
Velocity of money
1) Industrial output
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 and 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.
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
2) Employment
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, a 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 alack 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. This will then cause 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.
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.
3) Money supply
The third variable is the money supply. Money supply is probably the hot topic issue at hand because it has been massively increased as the money printer has gone BRRRRRRRRRRR.
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 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.
4) The velocity of money.
The federal reserve could theoretically print 1000 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 same 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 which are things that are not part of the consumer price index and do not count towards inflation
Closing thoughts
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 will surely have 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.
We are not free and clear of hyperinflation and or stagflation 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.
Amazing! Learnt something new.