Ask Lemmy

Put aside all your personal feelings about money - how much you make, have, save, spend, or need. Money doesn't mean anything, it is just a means of exchanging value so that someone who does plumbing for a living doesn't have to also grow their own food and mine the metal to make the pipes.

A market economy is decentralized, there is no single decision-maker that mandates how many plumbers need to exist or how much pipe needs to be manufactured. Those decisions are made by market forces I.e. profit.

The information about how valuable something, someone, or some skill is in a decentralized system is determined through transaction. Money needs to flow in order to get accurate prices for everything and determine their value - valuable things have a market price that exceeds their costs to produce/maintain/etc. The greater the liquidity in a market (and the lower the cost to transact), the more accurate this information.

Inflation incentivizes spending money - on goods, services, or assets, rather than holding the currency itself. It can be thought of as a tax for withholding participation in the market. It increases liquidity and facilitates price discovery.

Broad deflation - the price of everything falling - is generally a sign of economic collapse. It means that no one wants what the economy is producing at the prices it can sustain... so stop making everything... food, houses, etc.

Sector deflation is quite common - electronics (until recently) got cheaper for decades - and this generally reflects increasing production efficiency and healthy marketplace competiton (good). But people spending less on TVs need to find somewhere else to spend that money to keep the system operating. Reducing spend overall is the signal to reduce output, which means recession, unemployment, etc. Economic contraction makes everyone poorer.

None of this would be bad if the life of the median person wasn't balanced on a knife's edge over the abyss of homelessness and poverty. Against that backdrop, it can often seem cruel that the system is designed in such a way that everything gets more expensive all the time. If your earnings aren't keeping up with or exceeding inflation, however, it is the system telling you that the role is being culled. Find a new job (obviously easier said than done in most cases).

Inflation is, in fact, a way of making sure the economy isn't a zero-sum game.

it forces people put their money into assets, which causes them to spend, that moves the economy

In my mind, it's not that inflation is good, but that deflation is far, far worse. The problem with deflation is your money buys more tomorrow than today, so you hold off spending it. Done en masse, that causes demand to drop. With people buying less, companies have to lower prices further, which means more deflation. It's a self-perpetuating cycle.

Perhaps ideally we would be right on the knife's edge between inflation and deflation, but we really do not have the ability to control the economy to that level of precision. The Fed can manipulate interest rates, print money, and that's about it. Congress, if it wants to, can pull economic levers by raising and lowering taxing and spending. But these tools are not precision instruments, and they take months to reveal their effects.

If you try and aim for precisely 0% inflation, you're likely to end up swinging between -1% and 1%. Which means you'll be spending significant time in deflationary territory, risking a deflationary spiral. The Fed aims for a 2% inflation target. This gives them some buffer to hopefully keep us out of deflation.

Google furry inflation

Focus on simplicity rather than details:

Deflation (opposite of inflation) encourages people to put money under the pillow and wait for it to increase in value. If everyone does this the economy stagnates.

Inflation encourages people to spend the money now or invest it. Your spending is someone else's income and their spending is your income. Investing is you risking your money to have someone else buy something that hopefully makes them more productive.

Too high inflation causes loss of trust in the currency and people start hoarding bricks or something else non perishable and the economy stagnates.

So central banks say that they will manipulate the currency so that the inflation is around say 2% which is low enough for people to trust it but high enough to encourage spending/investing.

I think the real key to understanding how inflation can be desirable is to understand that when economists talk about inflation it is with the assumption that wages will rise by an equal amount.

And, generally speaking, this is actually true. There's a lot of nuance to that statement, so please just trust that whatever counter you have is probably contained in the nuance. But, broadly, the math checks out. We will dig into that more, later. I promise.

So, the notion is that prices go up by 2%, and then your wages go up by 2%. So how does that help anything if all we've done by the end of the year is reset the status quo?

Well, there are two numbers that don't get immediately affected when your pay goes up; your savings and your debts. With slow, gentle inflation, both of these things will, over time, shrink relative to your income, while your actual buying power should, ideally, remain the same.

Say you buy a car and you agree to pay $300 a month for it. Five years later, your pay has gone up by 10%, but your car payment doesn't go up. It's locked at the price you agreed at the time, meaning it's now a smaller slice of your income.

Conversely, your savings effectively shrink every year. The combined effect of this is that people with lots of savings are encouraged to spend them, while people with lots of debts are rewarded. That means more money moves though the economy, creating a healthier economy, and it means that governments, who hold lots of debt, get to shrink that debt without ever having to pay it down. The UK government still holds debts from 300 years ago, because what was a massive expenditure at the time is now just a pittance. This is why governments can run permanent deficits (within reason) and not ever have to worry about the bill coming due; because it doesn't.

For individuals, mild inflation benefits those who buy things on credit rather than outright, which under normal circumstances means us regular shlubs who need mortgages and car loans.

If you're trying to understand why every business now cares only about juicing their share price and not about their long term health as a company, this is a big part of why. As inflation bites, the wealthy watch as their assets decrease in comparative value, so they want those assets to grow faster than inflation. That leads to a growth at all costs mentality.

So why isn't this working? Well, one problem is the one I just mentioned; we'll get back to that.

But the other reason is that not all inflation is the same. When prices go up because the economy is running hot, it means that the price of everything goes up. Everything includes your labour. But when prices go up because a pandemic made shipping more expensive, or because someone started a war in Iran, that increases the input costs your company is paying for whatever it is they do, but not their profit. So your boss doesn't suddenly have a bunch of extra money to give you a pay rise. The value of your labour hasn't increased, but the cost of things has. So we get price inflation without wage inflation.

So this is the real disconnect; there's good invitation and bad inflation, and they're not the same thing (and, frankly, the fact that we don't have different terms for them is the cause of a huge amount of confusion and misunderstanding).

Healthy inflation is the natural result of growth in an economy. Economies tend to grow, because the human population of Earth tends to grow, which means more people doing more labour, making more stuff and buying more stuff. And of course, over time we develop new technologies and practices that increase the amount of goods each human can produce, which increases what each human can sell and thus what each human can buy.

(A quick aside here; the math generally seems to agree that global population will actually stabilize at some point, probably at around 10 billion. So the human growth portion of this equation is probably only over a specific timeline, and that's without even factoring any kind of intentional degrowth.)

The problem is that what we've been seeing for much of the last decade isn't inflation, it's price shocks, the "bad inflation" that I referred to.

If you think back past 2020, you'll recall that the word inflation really wasn't in the public vocabulary in the same way. It was really only something that was being talked about by weirdo libertarians, who then used the combination of price shocks and massive government spending in the pandemic to sell this notion that this why governments shouldn't spend money. This, of course, completely ignores that governments across the world spend truly unimaginable amounts of money resolving the financial crisis just ten years earlier and inflation remained so stubbornly low that Japan had to go out of its way to try to create some.

So, in short, moderate, controlled inflation good, price shocks bad.

In theory.

But of course, there's more to it than that, because we all agree that the quality of life we can afford today and the quality of life we could afford even as recently as the 2000s are not the same thing. The Simpsons are supposed to be a working class family barely getting by and they live in a palace by modern standards.

This is because the way we measure "inflation" doesn't work. At least, not for our purposes. To put it really simply, if you compare what we have now against the nineties, as a portion of our income TVs and computers have gone way down, while houses and college degrees have gone way up. That's the problem. The things we want are cheaper while the things we need are more expensive. And as income inequality worsens, this problem only gets worse, because the wealthy can afford to buy up all the assets like housing, raising their price.

The other problem is that wages increasing in line with inflation relies on labour having the power to demand increased wages, and that's something that's being steadily stripped away from the poorest workers. Your six figure workers can still generally demand regular pay increases, or hop jobs for a bump, but the guys pulling shifts at McDonald's aren't seeing those same opportunities. So while, in aggregate, wages do tend to keep up with inflation, in reality the distribution is skewed. This is where governments need to step in with things like minimum wage increases which bring the floor up for everybody (this is why, in practice, minimum wage increases have never been observed to increase inflation; they're just correcting the side of the equation that's currently unbalanced) and why it is absolutely vital that we protect and encourage the ability for labour to organize and collectively bargain. If we're going to have capitalism forced down our throats, mandatory unions should be a bare minimum guardrail.

So yes, steady, moderate inflation is good... And has absolutely nothing to do with why everything is unaffordable now.

For an individual, inflation allows

• you potentially get a raise every year
• your house increases in value over time

It's pretty simple. Borrowed money by the government can be paid back with inflated (less valuable) dollars.

You have 2 questions:

1. Why is a little bit of inflation desirable?
2. But if the economy always needs injections of liquidity because otherwise it fails, isn’t the economy broken?

Most replies I saw dealt with only the first question.

First off - why some inflation is good: you got some good answers, but from what I saw, people talked about savings and debt but not consumption. Let's say you're thinking about buying a new TV. It costs $200, which you have, but you're still on the fence. If you know that the next month the TV will cost $201, that just might be the push you need to buy it. But why does the economic system wants you to buy the TV now? Because everyone wants to get money sooner rather than later.

"Wait, so it's just a scam to get my money?" Kinda, but not in a bad way. Money isn't real, and you don't gain anything by just owing money (investments are another thing). The sooner everyone gets your money, the sooner they'll be able to use this money to do stuff, which will stimulate the economy. The same mechanism (albeit with some qualifiers) also increases your paycheck at the same rate, so the only way you lose out is if your money is just laying there doing nothing.

Now to the other part: "But if the economy always needs injections of liquidity because otherwise it fails, isn’t the economy broken?" Money isn't real, man.

The system doesn't really get "injected" with anything. What happens is that the government (well, central bank) prints out cash and gives it to banks as a loan. The banks are always happy to get money because they can use it to give out loans of their own. The government gets the money back with (a small) interest, so they're also happy (and that's why inflation is, in essence, a form of tax).

"Whoa there, the banks have to give the government the money BACK? so, at some point the banks have to get all of their money and give it to the government!? This is so much wore than I thought!" No no no, the banks repay the loan with MONEY not CASH.

"OK, Dude, you lost me" So, this is where it starts getting a bit complicated. Let's say you have $200 in your checking account. The bank doesn't actually have a $200 bill with you name on it. You want your $200 in cash? Sure, the bank will pull a $200 bill from its vault, but it's not your personal $200 bill in the vault, and you probably don't even want a $200 bill anyway (you'll just pay the $200 with a credit card or whatever, and the bank will transfer the money digitally), so why bother? The bank just has to have enough cash to give to people who want it. The central bank sets a certain percent of cash that the banks must have against certain assets (ex. they must have 20% of the value of all checking accounts in cash). When the bank gets more cash, what it actually gets isn't money, but permission from the government to loan out more money to people who want it.

The government loans cash to banks. The banks then give loans to other entities (companies/people) who want money now and can probably repay it later. This has the side effect of increasing both prices and wages while encouraging entities to use their money so that companies will want to keep making stuff they can sell. Win-win-win-win. Well, except people who have money just laying around not doing anything and having it decrease in value, they are the ones who are paying the inflation tax.

Bonus question: "Ah, so the reason we don't want the inflation to get too high is so that the people paying the inflation tax won't get taxed too much, otherwise the more inflation the more wins?" Nah, the people who pay the inflation tax are mostly poor, so screw 'em. Like with everything in economics, it's a balancing act. High inflation takes away stability. In the beginning I said "you know that the next month the TV will cost $201". But in reality, you don't KNOW it, you assume some inflation. If people think inflation will be 2% and it's actually 2.5%, that's fine for the most part. But if they think it'll be 200% and it's 250%, that's a difference of half the money people had at the start of the year, and is kinda a big deal. Also, the economic environment can't react immediately to a price increase, and if the prices increase faster than the economy can react, it starts to break things and creates a feedback loop that increases inflation even more (which takes away MORE stability). This is called hyperinflation, and what economist consider An Extremely Bad Thing. An inflation of around 2% is considered the sweet spot for most modern economies. This is also the exact reason the central bank is the one in charge of printing money (and is actually the main reason there is such a thing as a central bank) - printing money is a very easy solution to governmental budgetary issues, but is also extremely dangerous for the economy as a whole. Just having the government a theoretical option to go there takes away financial stability from the system, so it's much safer to have an independent professional institution to handle it.

Japan had deflation for 35 years, and keeps a mostly stable economy. Is inflation actually desirable? If you look at economics long enough it starts being about subjective politics, and systems people oversee and behave in. Somethings are true some times with certain goals, other things are true other times.

Inflation is more a byproduct of certain circumstances.

Let me add: I'm an engineer. By reason of existence, my work involves improving how we do stuff. My work involves helping people work more efficiently, use fewer resources, cost less etc. We should be doing more, with less because the tools and methods get better. So why do things keep getting more expensive? I don't grok inflation. Not a bit of it.

I do understand that it's done to "stimulate" the economy so people don't let their cash rot in a checking account, but isn't it a zero-sum game?

The issue isn't keeping money in a checking account, but under your mattress. Even in a checking account, your bank can still use a part of the money to create loans. Under your mattress, the money does nothing and that makes it more expensive for people who need money to pre-invest in something.

But if the economy always needs injections of liquidity because otherwise it fails, isn't the economy broken?

Kind of, but requiring cash on hand with no lending at all breaks the economy a lot more. It forces all investment to occur to only people who have money and it makes running out of money a much easier thing to happen. If you read accounts of eras where money was much harder to be lent, you'll see cash flow issues were much more significant even for large companies and corporations.