Why is inflation so bad?

Source: Marginal Revolution.

Tyler Cowen wants to know. I think I can explain.

First, I should note that Cowen isn’t concerned with the current rate of inflation (the highest in more than 30 years). He is wondering, instead, why do economists — almost universally — have a negative view of inflation.

In other words, Cowen is asking a question about theory by way of pointing out that economists don’t have a theory to explain why inflation is undesirable. So, here is my explanation.

Inflation is a type of devaluation in which the same quantum of money trades for fewer goods. Cowen observes that generalized inflation can affect both the income and expenses of an affected population such that the only thing that changes is the price level the members are accustomed to operating with.

Suppose, for example, the objective value of a unit of bread is the amount of labor a bread-eater expends to obtain it. If all goods have a similarly defined objective value, then prices could rise across the board, including the price for labor, such that the objective values remain the same. Specifically, if the bread-eater once worked an hour to buy a loaf of bread for $1.00, he could just as easily work an hour to buy a loaf of bread for $2.00, assuming his income rose to cover the increase.

But what if, instead, there is no objective standard of value? More generally, what if there is no mechanism, no unseen hand, to cause a population’s income and expenses to remain in balance? What if income and expenses naturally vary independently from one another?

In that case, any price increase at all must be a very scary thing. When there is no certainty that higher expenses will be met with higher income, any single price rise might be the flapping of a butterfly’s wings that initiates a chain reaction that builds into catastrophic chaos.

Put another way, if income and expense levels naturally vary independently from one another, then the entire economy is necessarily fragile in this respect such that any minor disturbance could destroy it.

I imagine that economists grasp this intuitively since, like Cowen, they know economic value is purely subjective.

8 thoughts on “Why is inflation so bad?

  1. The big problem with inflation is that it tends to snowball.

    Everyone recognizes it and seeks to protect themselves. Consumers hoard staples for fear that they will be too expensive later. Manufacturers do the same, hoarding raw materials. That creates shortages which drive prices up.

    Sellers withhold products to get a better price later, That also creates shortages.

    Investors borrow to invest expecting big gains as stock prices are driven up as people flee from cash. That eventually drives interest rates up.

    Workers seek gimmicks to keep up too. Unions negotiate ‘cost of living escalators’ to tie their wage to indicators of inflation. They think this is a new idea, but during the Weimar inflation, workers were paid hourly based on the latest value of the mark, and their wives were waiting for the pay cart in the factories to rush out and spend the money as grocery stores raised their prices hourly as well.

    Eventually, the billion mark note was printed on only one side as if both sides were printed, the cost to produce the note exceeded its value.

    Like

    1. RE: “The big problem with inflation is that it tends to snowball.”

      Bad money drives out good, causing more bad money, driving out more good, causing more bad money, etc.

      Like

    1. Hysteria does play a part. People take on debt they know they cannot pay back at their current wage, anticipating being able to repay it with cheaper dollars.

      Back in the Carter inflation, when all interest was tax deductible, it actually made sense to buy stocks with your credit card.

      Like

      1. “The Carter Inflation?” LOL!

        You have managed to put Richard Nixon and his policy of wage and price controls out of your mind?

        Why did Nixon have the government dictate every price and every wage?

        Uh, that would be INFLATION. And yes, it did continue under Ford and Carter and it was exacerbated by OPEC oil shenanigans but it was a problem Carter inherited. With your heavy load of free market ideology you should be able to acknowledge that Nixon’s unprecedented meddling (before or since) with market forces had effects that rippled through the economy long after he was gone. So, let’s call it the “Nixon Inflation” if we want to put a label on it.

        Liked by 1 person

        1. The inflation, and the price controls, did start under Nixon. But inflation never exceeded 9% while Nixon was in office, and was only 8% for one year, while it was never under 9% while Carter was in office, peaking at almost 14%.

          Like

          1. So, it did start under Nixon and neither he, nor Ford nor Carter was able to stop it. The truth of the matter is that nothing that Carter did caused the inflation that occurred on his watch. And you are hypocritically giving Nixon some sort of credit for the effect of his truly massive interference in the market.

            Here is a balanced summary of 1970’s inflation without the hyper-partisanship that you are trying to interject with your labelling.

            https://www.npr.org/2021/05/29/1001023637/think-inflation-is-bad-now-lets-take-a-step-back-to-the-1970s

            Note that it was Paul Volcker and the Fed which finally ended it. This is history worth knowing as the Republicans try to stoke the self-fulfilling fear of runaway price increases.

            Liked by 1 person

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s