Inflation is not a thing. It is a measurement of a tendency of an abstraction that we all unthinkingly regard as a thing. Inflation, in and of itself, is neither good nor bad. It is when we reify inflation (mistakenly regarded as a thing), which is almost inevitable once we've reified money (also mistakenly regarded as a thing), that it causes such headaches.
There are several points about inflation that bear discussion:
We all know what inflation measures, which is the overall decrease in the value of money or, put differently, the overall increase in the price of everything else. What is more difficult to agree on is the question of what causes inflation.
There is the wage-push (or price-push) theory, which is what prompted the Canadian government to impose a
wage-and-price control policy in 1975 (after having just campaigned against it). Big labour demands higher
wages, prompting big business to demand higher prices, prompting big labour to demand higher wages, etc.
The big question, of course, is why does big labour (or big business) all of a sudden decide to get greedy?
What were they doing all those other years, just sitting on their hands? Specifically, neither union density (at
about 30%) or business concentration changed significantly during the 70s. The push theory might help to
explain the persistence of inflation - through the creation of inflationary expectations - once it has been
triggered (that was the government's argument in 1975), but it doesn't explain the trigger.
Another theory is the Phillip's curve, which suggests that inflation and unemployment are inversely correlated.
As unemployment goes down, inflation goes up. Much as this theory appeals to logic, it doesn't often work in
real life. The "stagflation" of the late 70s was a big exception - where unemployment and inflation rose in
lockstep. Also the recovery of the mid 90s - where unemployment dropped to the lowest levels in 30 years and
inflation actually dropped to zero at times.
Monetarism is the theory that inflation is what happens when the money supply grows faster then GDP, either because of government-created "funny money" or excessively low interest rates, which encourages people to borrow more. The idea of monetarism is that when the money supply grows too fast, the capacity of the public to buy more stuff grows faster than the capacity of the firms to produce more stuff. Producers will respond to this growth in demand, but it takes time to step up production, expand facilities, hire and train more people, etc. In the meantime, the prices of those sought-after goods goes up until the supply can be raised to match the demand. Since there's more money than stuff in the economy, the would-be purchasers bid each other up for that last cabbage patch doll on the shelf. And, of course, the steps that companies take to increase their supply tends to feed back into the basic growth in demand.
The question becomes: why is demand growing? Is it because interest rates are low and everyone's borrowing money? Is it because unemployment is low and everyone has money burning a hole in their pockets? Is it because irresponsible governments are printing money to appease ignorant citizens? Monetarists argue that the cause is irresponsible governments printing too much money. Hence, a high interest policy is to be preferred, because it attaches a premium on money, discouraging people from borrowing it, and this slows down the economy, killing job growth. Hence, the two inflationary beasts (employment and easy money) are dispatched with one fell swoop.
Of course, this theory doesn't explain why there was inflation in the late 1970s, even as the economy slowed and jobs were destroyed. That was a
special case: since our economy is so wholly dependent on oil, a significant increase in the price of oil will impact the prices of everything else. This is because in many products - especially consumer durables - oil is a direct ingredient in their production, and in all products, oil is used to fuel factories, transport materials, transport completed products, etc., etc. If it costs $100 to make a widget, and of that $100, $10 is spent on oil, think of what happens when the price of oil quadruples (as it did in the OPEC crises). Now, the product is $130 dollars (that $10 became $40). Incredible amounts of money were siphoned out of the American economy to the Middle East, and then loaned back to America at high rates of interest, so this was a secondary inflationary pressure. Then, people came to expect high levels of inflation, and negotiated costs based on the inflationary expectation, which was a tertiary inflationary pressure.
Overall, things haven't worked out the way the monetarists claimed they would. After applying monetarist
principles to central banking (leave money creation to private banks, raise interest rates), inflation actually got worse
in the late 1970s. Of course, it was a monster in '79 with the second oil shock, and it wasn't until Paul Volcker pushed
interest rates to 21% that the economy finally gasped and fell dead. This put millions of people out of work and
caused tremendous pain and misery. And it still didn't kill inflation.
There is no "inflation" in individual products. This is a classic fallacy (take heart, even the chairman of the Bank of Canada is guilty of this one): it makes no sense to speak of "inflation in gasoline" or food, or stock prices. No one can agree on what causes inflation there is no question that inflation is a general rise in the price of EVERYTHING. If the price of lumber goes up, it means you have to pay more for lumber. It doesn't mean that there is inflation in the price of lumber. Of course, this didn't stop the chairman of the Bank of Canada from using rising lumber prices to defend interest rate hikes in the early 1990s.
All of this begs the question: why is inflation such a big deal? If inflation is 4% and your wages go up 4%, then you're exactly where you started out. If your wages go up 6%, then you're slightly better off. Money is a shared abstraction and inflation is a mechanism of that abstraction. Most people aren't affected by moderate levels of inflation. Only holders of long term bonds are affected, because if inflation rates go up, then they will be repaid in softened currency when they cash in their bonds. Are we going to punish a whole economy (through devastating interest rate hikes) to protect the gross capital gains of a small number of wealthy bondholders (who will still make profit in an inflationary regime, albeit less profit)?
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