What's the problem with inflation?

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liberty
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What's the problem with inflation?

Post by liberty »

Real wage decreases is a problem. Negative real interest rates is a problem. But is inflation in itself a problem?

The only problem I see is that people have to all the time adjust their conceptions of what's cheap and what's expensive. "Is a $5 bread cheap?" etc. This is normally not a bit issue, even with 5 - 10% inflation rates, it's easy to adjust for this every year (or quarter?).

Is inflation a problem? Or is the real problem (that people complain about) real wage decreases and negative real interest rates, just that people call it "inflation" due to lack of Economics 101?

zbigi
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Re: What's the problem with inflation?

Post by zbigi »

Inflation decreases the trust in country's currency, as it stops serving one of its pursposes - being a reliable short and medium-term storage of value.

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Re: What's the problem with inflation?

Post by jacob »

liberty wrote:
Fri Jun 24, 2022 8:57 am
Is inflation a problem? Or is the real problem (that people complain about) real wage decreases and negative real interest rates, just that people call it "inflation" due to lack of Economics 101?
The problem is that inflation doesn't hit all groups of society evenly. People with debt or debt-based leverage, typically loaners, businesses, and governments will benefit from inflation. People on fixed-income like lenders, retirees, and businesses who can't push their increased costs onto increased revenue will suffer.

The general belief seems to be that some level of slight inflation (2-3%) is the best compromise in a developed economy in terms of employement, business development, etc.

If this is taken as a norm, then high inflation devalues the contribution of the latter mentioned above. Basically, the future becomes untrustworthy. People convert wealth into immediate stuff to avoid losing out personally even if it would have been better for society if that money had been invested in the future.

TL;DR The nominal percentage also matters in terms of how debt is issued and sold. Numbers that are very high or very low compared to the real growth of the economy plays havoc on the debt markets.

Dream of Freedom
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Re: What's the problem with inflation?

Post by Dream of Freedom »

Inflation is an indicator of bigger problems. When prices go up substantially it is often caused by supply disruptions. Supply disruptions mean that some people won't be able to get what they need.

There are other things to consider. Contracts, for instance. Contracts provide predictability in the supply chain. One party is assured that a product will be available while the other is assured there will be a customer, but if you contract out to sell at a certain price and the input costs go up before you provide the product you have to eat the difference. Inflation also encourages consumption. If your dollar is worth less tomorrow maybe you should spend it today. Though that is good for GDP it isn't always optimal for individuals.

chenda
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Re: What's the problem with inflation?

Post by chenda »

jacob wrote:
Fri Jun 24, 2022 9:55 am
The general belief seems to be that some level of slight inflation (2-3%) is the best compromise in a developed economy in terms of employement, business development, etc.
Could you argue a 2-3% deflation might be an equally effective compromise ?

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Re: What's the problem with inflation?

Post by zbigi »

chenda wrote:
Fri Jun 24, 2022 11:08 am
Could you argue a 2-3% deflation might be an equally effective compromise ?
The standard argument against deflation is that it encourages just keeping money in the mattress (its value will grow while it just lies there), while slight inflation is enough to encourage people to put it in the bank and hence into the economy. Also, deflation promotes saving and discourages consuption, which is seen as bad for economy.

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Re: What's the problem with inflation?

Post by jacob »

chenda wrote:
Fri Jun 24, 2022 11:08 am
Could you argue a 2-3% deflation might be an equally effective compromise ?
No.

Lets say, for the sake of the argument, that the real economy is deflating (say a negative -3%/year) due to having reached some kind of limit e.g. total factor productivity growth is now 0% or negative (<- people are getting less efficient because maintenance debt is becoming an issue) or because it has overshot a constraint (e.g. energy or mineral inputs). Effectively, each year less and less is being produced because it is physically impossible.

If we set the nominal inflation rate to -1%, people will hang on to their money because they're effectively getting a 2% interest rate relative to the declining amount of stuff. They can buy 2% more stuff nest year relative to anyone else even if they get 1% less than last year. They're "winning" relatively even as society as a whole is losing.

If we set the nominal to -7%, people are getting a -4% return on their cash (the monetary deflation you're asking about) relative to the stuff. This will cause people with cash (and cash-like instruments, like fixed income) to hoard stuff. However, in a declining situation that would be like burning the furniture to stay warm.

So the inflation rate should always be >0 if possible. This is because this direction points to the future and it's actually possible to influence the future from the present. <0 points to the past which is fixed.

The only exception for negative interest rates is to suck money out back out of the asset class if it's societally deemed they have too much. This is kinda what the central banks are attempting now. This is only possible because there is far more money in the world than there is actual stuff. As such the asset class can't escape into stuff.

WFJ
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Re: What's the problem with inflation?

Post by WFJ »

Someone could write several textbooks to answer the question. Short answer is inflation helps the rich, crushes the middle class and hides government debt/spending. It is a truly evil tax imposed on middle class wage earners and if left unchecked, destroys societies. The policies that created today's inflation were created by Yellen starting in 2010 and will take a significantly long time to tame. Taming inflation is called "Grabbing a dragon by the tale" as once it's out, it will cause massive damage.

If I had a magic wand and could maintain 100% real purchasing power and give up all market returns for the next 10 years, I'd take it (TIPS only maintains government inflation and has had a negative yield until recent auction). Unfortunately, inflation will rip apart many ERE plans. IMHO, nowhere to hide.

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Re: What's the problem with inflation?

Post by chenda »

WFJ wrote:
Fri Jun 24, 2022 3:34 pm
The policies that created today's inflation were created by Yellen starting in 2010 and will take a significantly long time to tame.
I'd suggest covid and ukraine are the primary reasons for inflation. Circa 2010 austrian economists kept claiming we were on the verge of hyperinflation and they were very wrong, and the keynesians called it right.

Now over a decade later and inflation finally materialises for unrelated reasons they are trying to claim some kind of retrospective vindication. Any predication will come true if you wait long enough.

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Re: What's the problem with inflation?

Post by chenda »

@jacob Right that's interesting, I've often wondered if we could actually run a modern economy without debt. Islamic banking attempts to do this although it seems they have had to compromise a lot on this to the matter.

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Re: What's the problem with inflation?

Post by jacob »

chenda wrote:
Fri Jun 24, 2022 4:51 pm
@jacob Right that's interesting, I've often wondered if we could actually run a modern economy without debt. Islamic banking attempts to do this although it seems they have had to compromise a lot on this to the matter.
Maybe we can run a postmodern one or a post-postmodern one. There's a slew of financial products that each allocates risk to the party or the counterparty on a sliding scale. It is at least conceivable that financial contracts could be written putting the risk exclusively on the owner. However, this would be the end of e.g. borrowing to buy a house. The investor would instead start owning 100% of the house while the occupant would sequentially buy the shares back in turn reducing the dividend to be paid out. This means that the occupant would most likely no longer have "home owner" rights until 51% was owned. Also, the investor would technically be free to set the price for selling the shares. In short, the dynamics would be "very interesting".

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Re: What's the problem with inflation?

Post by chenda »

@jacob yes I think thats how Islamic mortgages work. The bank buys the property and you incrementally buy the property from them, and pay partial rent on the rest. The rental is effectively the equivalent of the interest rate, which may vary. Apparently some non muslims like to use Islamic banking as it is perceived as safer, as theres less risk of engaging in things like derivative tradings.

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Mister Imperceptible
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Re: What's the problem with inflation?

Post by Mister Imperceptible »

it forces clean cut kids from the suburbs to mow lawns

prudentelo
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Re: What's the problem with inflation?

Post by prudentelo »

Without comment on eg. Weimar hyperinflation and similar, probably no economic problem with letting 8% inflation for 3 or 4 years while covid money supply expansion excretes from the system.

But perception is otherwise and inflation stated to discredit the system, so got to stop it.

prudentelo
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Re: What's the problem with inflation?

Post by prudentelo »

chenda wrote:
Fri Jun 24, 2022 4:46 pm
I'd suggest covid and ukraine are the primary reasons for inflation. Circa 2010 austrian economists kept claiming we were on the verge of hyperinflation and they were very wrong, and the keynesians called it right.

Now over a decade later and inflation finally materialises for unrelated reasons they are trying to claim some kind of retrospective vindication. Any predication will come true if you wait long enough.
Outside internet debate both Keynesian and Austrian are unusual positions. Current mainstream of economics doesnt think CB can expand the money supply forever with no inflation. Only notes that inflation due to money supply increase can be countered by money velocity decrease.

One caveat is that money velocity can increase again in future, but increased money supply is still there, so possibility for time bomb with unknown fuse length.

Recent (covid) events are not unrelated, because money supply expansion was faster than normal during covid, but money velocity reduction also greater than normal because of lockdowns (et cetera). So, very easy to explain qualitative events with "normal" economic theory. Less clear why Fed quantitative predictions were wrong, but system is very hard to quantitatively predict. Need model not just of Fed-controlled input, but also predictive model of human behavior changes.

Supply shock generally shouldnt increase overall price level. Increase spending on Product A (e.g. gas) should be canceled by decreased spend Product B (e.g. trucks, sit on mowers...). In short term , people keep their habits and spend down saving or take on debt. But probably not in medium or long term.

zbigi
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Re: What's the problem with inflation?

Post by zbigi »

prudentelo wrote:
Sat Jun 25, 2022 4:23 am
Without comment on eg. Weimar hyperinflation and similar, probably no economic problem with letting 8% inflation for 3 or 4 years while covid money supply expansion excretes from the system.
Inflation tends to get momentum of its own and can get sticky (people accept constantly raising prices as the new norm, so businesses start to routinely raise them). Poland started at 6% inflation several years ago, and now we're at 14%, predicted to reach more by end of year. It's better to squash this thing before it gets out of control.

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Re: What's the problem with inflation?

Post by jacob »

zbigi wrote:
Sat Jun 25, 2022 8:52 am
Inflation tends to get momentum of its own and can get sticky (people accept constantly raising prices as the new norm, so businesses start to routinely raise them). Poland started at 6% inflation several years ago, and now we're at 14%, predicted to reach more by end of year. It's better to squash this thing before it gets out of control.
I visited Poland in 1991 and again in 2002 and 2003. I remember the general attitude/culture---at least for those I visited---was that cash was crap. Better to put one's money is "small luxury"-items like mach3 razor blades ASAP. How did this eventually play out?

zbigi
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Re: What's the problem with inflation?

Post by zbigi »

jacob wrote:
Sat Jun 25, 2022 2:24 pm
1991 was hyperinflation caused by transition to market economy (251% in 1990, 585% in 1991). Totally wild, but got squashed fairly quickly by Chicago-inspired ("hawks") economists at Polish central bank. Thanks to them, in 2003 the inflation was barely there at 0.8%.

The prevailing attitude during hyperinflation was to just buy dollars or german marks as durable store of value. Spending it all was probably also a popular strategy, but I was only 10 at that time, so wasn't very privy to financial decisions.

BTW the hawkish attitude of Central Bank really wrecked the economy and caused a lot of social unrest. It's kind of amazing that these guys were just allowed to do it - I guess there was more faith in experts back then than now (nowadays, ruling politicians would tell them to make the policy hurt less, i.e. become less effective).

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Sclass
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Re: What's the problem with inflation?

Post by Sclass »

That is fascinating. Must have been interesting being in the middle of all that.

This is the kind of inflation caused by a loss of faith. I’ve only experienced the “too much money chasing too few goods” variant. Though I saw prices increasing I never could relate it to the stories of hyperinflation in places like Weimar Germany or Mugabe’s Zimbabwe. The loss of faith type is a very different thing.

My personal favorite was cost of living in Silicon Valley running away during the dot com bubble. All of a sudden some people ended up with a lot of money to spend and there just weren’t enough houses, cars and fancy dinners to go around. Not to mention tantalum capacitors and fiber optic transceivers. Prices in those areas spiraled out of control. It wasn’t a problem if you didn’t need a near IR semiconductor laser or a home in Mountain View, CA or if you were a player in the new internet business bankrolled with dumb money. But if you weren’t you were out in the cold and struggling to afford life with the salary of a public educator for instance.

zbigi
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Re: What's the problem with inflation?

Post by zbigi »

Sclass wrote:
Sun Jun 26, 2022 5:53 am
That is fascinating. Must have been interesting being in the middle of all that.
I was just a teen back then, so didn't observe all that much but yeah, those were the crazy times. Hiperinflation was one thing, but suddenly allowed laissez-faire free market economy (the bill allowing private commercial activities passed in 1989 was just a couple pages long IIRC, with the assumption that anything not explicitly forbidden is now allowed) was even more fascinating. The were untapped opportunities across all market segments, and millions of Poles started running small businesses on the side of their main job or instead of it. The people who were particularly good at it quickly became millionaires and are now running the Polish economy for the most part - people with nothing (except some party connections, which were still crucial in the 1989-1991 period) literally created multibillion banks just 30 years ago. And, unlike the oligarchs in post-soviet states, it wasn't based on stolen state propriety.
Another funny artifact of those times was that Western/American businesses started pouring into Poland trying to grab as big a market share as possible, so if you were in your early twenties, graduated from some business school and (crucially) your English was good, you could be offered high-level management position on the spot, e.g. on the street when you were buying cigarettes.

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