The Problems With Inflation

Inflation is a difficult subject, which is why most politicians avoid it.  Most definitions of Inflation tend to focus on one of its main effects, increase in prices.  Inflation is really an increase in the money supply relative to the number of goods being produced.   If there is more money than goods, the money is worth less (if there is too much money, it becomes worthless).  The opposite condition is called "deflation."  Deflation occurs when production of goods increases and more money is not created.

There is a general rule.  Inflation is good for whoever gets the money first (i.e. government, banks, large corporations) and deflation is good for whoever gets the money last (small businesses, workers).  Governments usually create the money, so they try to convince the populace that inflation is good.  That is because they want to have the ability to create money in order to reward constituents.  Notice that the Federal Reserve in the United States has an inflation target, not a deflation target or stability target Why is 2 percent the Federal Reserve's inflation target? Because it is. In the United States, money creation has been shifted to the banking system through creation of credit.  Banks also have an interest in creating inflation.  The more money they can lend, the more profit they can make.    Actually neither inflation nor deflation is an ideal condition.  The best condition is where the amount of money roughly matches increases in production and population.  Since this cannot be achieved perfectly, a money should go through brief periods of inflation and deflation, with the goal of keeping money stable. 

Problems with inflation--

For the individual--  Worker's' salaries do not keep up with inflation.  Workers in the United States today have seen their buying power decrease steadily.  Inflation also takes away the power of saving and investment for the average family.  30 years ago, somebody who had a million dollars or won a million dollars in a lottery was considered to have enough money to last forever.  They could be said to be rich.  Now, people who are trying to retire with one million dollars in investment accounts are finding it is not enough money for even a modest lifestyle.

For public policy--  Inflation creates an environment where the government is trying to catch its own tail with various entitlement programs.  The federal government collected little money for entitlement programs like Social Security and Medicare.  In 1975, the average recipient of Social Security received around 200 dollars per month.  What would that buy today?  Now, the average recipient receives more than $1300 per month.  The problem is that when they were workers in 1975, they only paid an amount of Social Security Tax sufficient to cover $200/month.  In fact, most did not earn enough annual income in 1975 to support a $1300/month payment later in life.  Inflation means that government has to cover that difference.  The crazy thing is that $200/month in 1975 bought more than $1300 today.  The average rent payment was only about $80 per month  Rent of Primary Residence Inflation Calculator .  Due to inflation, an $80 monthly rent is impossible today. 

Next time, we will go into some plans to stabilize currency.