Economists and Inflation: What They Often Overlook
In discussing inflation, it is often simplified by observing that if everyone suddenly has more money in their pockets, goods and services will adjust their prices to maintain value. However, the complexity of inflation goes beyond just money supply. It involves intricate interplays between productivity, government policies, and economic cycles. This article delves into the underlying dynamics that economists sometimes overlook, providing a comprehensive analysis of why inflation is a multifaceted issue.
Understanding Inflation
The concept of inflation hinges on the idea that when the money supply grows faster than the increase in goods and services available for purchase, prices generally rise. This relationship is crucial to understanding the broader economic phenomena. Simple examples illustrate this principle: if a sudden influx of 100 dollars in your pocket leads to a proportional increase in prices, and a year later, even with higher productivity, prices may only go up by a smaller margin.
For instance, imagine you have 100 dollars one day, and the next day, everyone has 200 dollars, prices will adjust to maintain the same value. If the next year the productivity of goods and services doubles, prices could increase by less, say 95 dollars. However, if productivity increases are not accompanied by a proportional increase in the money supply, prices may not rise as much, say 75 dollars.
Broad-Based Changes vs. Temporary Fluctuations
While inflation is often discussed in terms of broad-based price increases, it is important to note that certain price fluctuations are temporary. For example, a natural disaster that destroys a microprocessor chip factory can cause temporary price increases for various goods and services. Similarly, a sudden rise in oil prices can lead to increased costs for gasoline, diesel, and other petroleum-based products. These types of price changes are often local and temporary, especially when the event causing them resolves.
Conversely, inflation stemming from an increasing money supply is more persistent. When the central bank decides to keep the money supply high, it does not decrease automatically unless certain measures are taken. For instance, during the 1930s, the Federal Reserve's decision to reduce the money supply by about one-third contributed to a decline into a depression, leading to lasting fears of deflation, even though natural market mechanisms would have accommodated such changes.
The Historical Perspective
To contextualize, let's look at historical price increases. From 1792 to 1913, the cumulative price increases were just 8%. This means that what cost a dollar in 1792 would have cost merely 1.08 dollars in 1913. However, from 1913 to 2023, the cumulative price increases skyrocketed to a total of 2898%. Thus, what cost a dollar in 1913 would have cost 28.98 dollars in 2023. This significant rise is largely a result of governments' manipulations of the money supply for political gains.
Not all of this added money ends up in general circulation. Some may find its way into long-term assets like stocks, bonds, or real estate, thus not immediately affecting general prices. However, there is only so much that long-term assets can soak up, leading to increasing monetary pressure on the general economy.
Current Trends and Their Implications
In recent years, the US money supply has grown exponentially. Between 2020 and 2022, the US money supply increased by nearly 40%. With such a rapid increase, it is evident that long-term assets alone cannot absorb the entire influx. As a result, the excess money supply inevitably spills into the general economy, driving up prices.
Economists often focus on factors like production costs and supply chain disruptions to explain price increases. However, they often miss the broader context of money supply growth and its implications. Understanding these broader dynamics is crucial for forecasting and managing inflation effectively.
Conclusion
The mechanisms behind inflation are complex and multifaceted. While economists pay attention to short-term fluctuations and local disruptions, the persistent issue of money supply growth is often overlooked. As governments continue to manipulate the money supply for various reasons, it is essential to recognize the long-term implications of these actions.