In the wake of the Coronavirus pandemic, Congress passed multi-trillion-dollar stimulus and relief packages to help people who were forced to stop working during the lockdown. Now that the bills are starting to add up, many Americans are beginning to worry that all this new money will affect the value of the U.S. dollar. Inflation is a genuine concern as it can devastate people in real terms and leave behind long-term consequences for an economy. So, what is inflation? Is it normal? Why should you be worried?
Inflation: A Primer
In modern economics, inflation is defined as the rise in prices for goods and services in the market economy. But the classical definition of inflation, which is primarily used by the Austrian School of Economics, is the expansion of the money supply (the creation of new dollars by the central bank). Austrians will usually differentiate between the two by using monetary inflation (money supply growth) and price inflation (an increase in prices).
A rise in price inflation can come from many different fronts. For example, a spike in demand for products can lead to higher prices since shoppers are willing to pay more. As another example, higher prices can be triggered by increases in production costs, like raw materials and employee wages. Price inflation can also originate from an increase in the quantity of money since it decreases the public’s purchasing power, resulting in more dollars being required to buy goods and services.
The Dangers of Inflation
For the last century, there have been extreme cases of hyperinflation that destroyed economies and currencies. The Weimar Republic in the 1920s, Bolivia in the 1980s, and Venezuela in the 2000s: These were just some of the countries to witness a significant spike in the money supply and prices. Images of people carrying wheelbarrows of cash to buy a loaf of bread have become synonymous with inflation. Today, Zimbabwe is home to the world’s poorest billionaires.
But do the dangers of inflation need to be so extreme? The negative effects of inflation can be a bit more subtle and gradual in the more advanced economies. These are generally the more common dangers emanating from monetary and price inflation, which target primarily savers, retirees (see below), low-wage workers, and lenders:
- A drop in real incomes (how much money someone earns after accounting for price inflation).
- Negative real interest rates on savings accounts (price inflation exceeds the rate of interest).
- A jump in unit labor costs because employees will demand higher wages.
In the post-Coronavirus economy, for example, the cost of food has risen by about 4% each month since April. This would not be enough to trigger widespread panic, but it’s still enough to make life harder.
Seniors can also suffer from price inflation since the value of their savings erode over time. Whether it is the depreciation of their capital or a higher cost of living, everything they have earned during their working years can buy less, which is difficult for a retiree living on a fixed income.
Opponents of the Federal Reserve System have often compared the central bank to a counterfeiter because it creates money out of thin air. Defenders will say that printing money serves a purpose. But does it? Everyone would like to have more money in their pockets. The problem is that when the stock of money is artificially increased without any boost in capital, productivity, or supply of goods, your purchasing power is severely diminished.