It is often said that inflation is the generalized and sustained increase in prices. This is not so. Perhaps we could say it colloquially, but rising prices are nothing more than a common consequence of inflation. We are used to hearing this erroneous definition because it is the one used in many economics manuals. But why is it used if that is not inflation? Well, because inflation measures the variation of the CPI in two time periods. So, if this variation is positive, prices have increased. But do not confuse what it measures with what it is. Be very careful because this has spread so much that it is now the only definition that is usually found and it is not the correct one!
Inflation is, really, the loss of value of the monetary unit. If the currency is worth less, the goods and services we acquire are more expensive, because the purchasing power of the currency (the price of money) has decreased.
Since time immemorial, states have created inflation (making currency worth less) by mixing less valuable metals into the coins in circulation, or by issuing paper money. This was a very common way of financing state expenses. By creating money or debasing currency, the state finances itself. Furthermore, as money begins to be worth less, debtors benefit, since their debt decreases in real terms. Who is the main debtor of an economy? Bingo, the state. Furthermore, despite generating price increases, blame can be placed on other economic agents. It is curious to see on the news how some politicians complain about the price increases of the shopping basket, when the price has increased precisely because of the inflation that they have created. But it is better to blame the pernicious meat or milk producer, who wants to enrich himself at the expense of citizens and therefore raises the price of his products. Nothing is more false than this.
Inflation also delights states because it is a camouflaged tax. If the state creates money, it can spend it on anything to increase its votes, but the more money there is in circulation, other things being equal, its value will be lower and prices (other things being equal) will tend to grow, which which means that the money citizens have is worth less. That is, the state can finance itself at the expense of people seeing their purchasing power decrease. It is similar to a currency devaluation. Obviously the long-term consequences of inflation are bad, but the politician’s vision is very short-term. And as Keynes said, “in the long term everyone is dead.” Let’s not talk about the higher revenue due to non-deflation, because that would be enough for another article.
Knowing these effects, no citizen would want inflation: loss of savings, monetary instability, etc. In fact, inflation that is not excessive, such as 3%, causes prices to quadruple in a person’s working life. Nobody wants this. But on the other hand it is very convenient for the authorities. Some of these effects of a society that lives with inflation, like ours, are: it makes it increasingly difficult for low-income people to cover their future with savings for their old age; discourages savings; encourages debt; By destroying the middle class, the threat of greater inequalities between high and low incomes grows; Short-term behaviors are encouraged by paying attention only to the immediate consequences of our actions; and many others.
One of the worst consequences of inflation is the unemployment it generates. If prices increase generally (as a result of the increase in the money supply, for example, which makes money worth less), many investment projects will be undertaken because they will have accounting profits. However, these benefits will be in monetary units with a much lower value. In addition, the creation of thousands of business projects is encouraged because it seems that they all have benefits. Many of these crazy projects will ultimately fail and many others will decline in profits or reap losses as the growth of the money supply slows. All those productive factors of human resources of the projects that have to cease their activity are fired. It is true that it is frictional and not structural unemployment, but unemployment, after all.
Economic theories that defend intervention in prices have even led to the total destruction of the monetary system of countries. For example, when inflation wants to be maintained over time, but economic agents foresee it or the pace of acceleration of money creation becomes slower, we can reach hyperinflation, or inflationary recession or stagflation.
This is what happened in Germany in the 1920s. The money supply increased so much that the marks ceased to have value. The price of the German mark fell so much that beggars warmed themselves by burning banknotes and children played with millions of marks. And, in nominal terms, all the workers were multibillionaires, but a loaf of bread was worth several million marks. The inflation was such that the price of bread was one for those at the front of the line and double or triple that for those at the end.
The German mark ceased to have value and people began to exchange in stamps, tobacco or other accepted means. This situation was the perfect breeding ground for Nazism. And the Germans, with their good memories, have the constitutional mandate of the Bundesbank to guarantee monetary stability (not the rest of the central banks, which also have economic growth as their objective).
Looking at the graph of the loss of value of the mark, think about buying a case for your child in 1918 for 1 mark. Well, 5 years later it would cost you a billion marks! In Venezuela, for the price of what a car cost, a year later, in 2017, you can barely afford the first dish at any restaurant. In fact, 2018 inflation in Venezuela was more than 1,500,000%.
To fully understand inflation, think about reverse exchanges. How many pens cost me one euro? Imagine that €1=1pen. That is, a pen costs me one euro. If they start producing a lot of pens, they will drop in price, so it will cost me, for example, 0.5 euros each pen. But imagine that, instead of the supply of pens increasing, it is the supply of money that increases. So what will cost me less will be to acquire coins.
That is, a pen costs me one euro. If there is inflation, a pen can buy two euros. Or what is the same, with one euro I can only buy half a pen. It is not that the pen has risen in price because the producer is making higher margins, but that the monetary unit has lost value.
Article extract from the book “The Courage of Ignorance”