Monday, March 03, 2008

What causes inflation?

March 2008 - This morning I heard a local bread baker say their flower prices have went from nine dollars a bag (not sure how big the bag is) to twenty nine dollars a bag in the past year. This confirms my local pizza guy's claim when he said their food costs have doubled in the past year. So this got me wondering, what causes these prices to inflate?

Appropriately enough, I'm taking a class called World Economy from the University of Minnesota. The first section covered how the Federal Reserve Board works. The second section is on inflation. Could my registration in this class be fate?

From what we've learned, inflation is when the value of a monetary representation (e.g. dollar) looses purchasing power. Remember that age old saying "a dollar today is worth more than a dollar tomorrow?" It's kind of annoying, but all too true. Every day, money looses value due to inflation. The percentage that is lost, fluctuates. Let's look at why.

Governments love to spend money. Defense, welfare presidential parties; they call cost money and someone has to pay for them. Similar to a fiscally responsible person or family, a fiscally responsible government will spend only what it can afford. We all know that the government is hardly ever fiscally responsible though, and so they have a propensity to run deficits.

Once a government has a deficit they have to pay for it. This can only be done on two ways; raise taxes or print money. Everyone knows how political raising taxes is. Many of us Republicans will vote a person out of office for even thinking of such a thing. And though I don't agree with the Republicans all the time, raising taxes will harm growth.

The other way to pay for a deficit is to print money. Basically this means increasing the money supply. Wouldn't it be nice if it was that easy? Just print money and everything is kosher again. Bills are paid and we can start spending once again. Sound too good to be true? It is.

When the money supply is increased, the value of existing money goes down. That's a fundamental of economics. Supply goes up, price goes down. Money is no different.

So where does this leave us? The U.S. government is running a deficient right now. In the long-term we can pay for this by raising taxes or printing more money. In the short term, we're paying by borrowing. Borrowing will only last so long. At some point, we'll need to pay.

Since raising taxes is so political, the only way to deal with our growing deficit is to increase the money supply. Meaning that our free government's free spending will eventually lead to higher inflation. Looks like that pizza guy down the road might have to raise prices even more in the near future.

1 comment:

David said...

n the long-term we can pay for this by raising taxes

Or lowering taxes...see the Laffer curve.

This is the idea being Reagnomics and as such, the Bush tax cuts.

Of course, the problem is that the Laffer curve is exceedingly hard to correctly approximate.