Fighting Inflation
We have all heard stories like "I remember when
a gallon of gasoline cost 23 cents," or "I used to be able to buy a
loaf of bread for a dime," so we are all familiar with the idea that
prices go up over time; what causes these price increases can be a little more
difficult to grasp. You have probably
heard the term inflation correlated with these price increases, but what
exactly is inflation, and how does it work?
Inflation is the term economists use to express the gradual rise in the
prices of goods and services over time due to an excessive number of dollars
being in circulation. This can happen
when the government prints too much money, or when it is too easy to borrow money;
the three main strategies to fight this are raising interest rates, stopping
the printing of money, and intentionally raising unemployment rates.
There
are a couple of different things that can cause there to be too many dollars in circulation: printing too much money and
lax lending practices, or monetary policy (Friedman 264-66). When the Department of the Treasury prints
excessive amounts of money, which the government in turn uses to perform its
various functions, it puts an additional amount of money into circulation
without an actual demand for that money, causing the value of the money to drop
(Sowell 389). Loose monetary policy has
essentially the same affect; when banks are given the ability to lend excessive
amounts of money, it gives people and corporations additional money to spend,
effectively putting additional money into circulation. This excess of money changes the value of the
dollar because of the affects of supply and demand.
Supply
and demand is the idea that when there is more demand for a product than there
is a supply of that product the price of that product is raised, and when there
is a greater supply of a product than there is a demand for that product the
price is lowered. Say, for example, that
you have the last ten oranges on the planet, and I have the last ten apples. If we both wanted to trade one of our pieces
of fruit with a third person who had 10 bananas, they would have approximately
the same value to the seller of the bananas.
Now let's say that a warehouse has been discovered with 1000 new oranges
in it. It would now "cost" you
a lot more of your oranges to acquire a banana while I could still trade one
apple for a banana. The value of the
banana hasn't changed, as evidenced by my one apple still buying one banana. What has happened is that with additional
oranges in circulation they have become easier to acquire, making them worth
less. We can see this same effect all
the time: priceless French paintings are "priceless" because they are
so rare. The same effects apply to
antique cars. Antique cars are actually
increasing in value as they get older and become less available, because the
demand for them far outweighs the supply.
When very few of something are available, people are willing to give up
more to get it; if more of those things become available, and they become
easier to get, people become willing to give less to get them. The same laws of supply and demand apply to
money; if an additional supply of money is available to purchase products, then
the value, or purchasing power, of individual dollars will be lessened.
When
there is excessive inflation, consumers can feel the effects of it every time
they go to the grocery store or fill-up at the gas pump. With a less valuable dollar, you have to give
more of them to get the same amount of goods or labor, effectively cutting your
salary by reducing its purchasing power.
Aside from the direct effects on consumers there are other, secondary,
effects of inflation. Businesses find
that even though they are getting more money for their products, it is costing
them more to make the products, and the money they get from selling their
products buys them less labor to produce more products causing their actual
profit to drop. When a business' profits
drop, they in turn end up either laying people off, raising prices more, or
some of both. This is all assuming
moderate levels of inflation; for an example of what happens when inflation
gets to the extreme we need only to look to post World War I Germany. In 1920 it took 40 German marks to equal one
dollar, but by 1923 it took over four trillion marks just to equal one dollar!
(Sowell 395). That meant that people's
entire life savings would not have bought them enough food to eat for a single
day.
Now
that we know what inflation is and the devastating affects it can have on
consumers, as well as entire economies, what can be done to halt inflation, or
lessen the affects of it? This can be a
topic of great debate. Several different
strategies have been employed with varying degrees of success, but there are
three main theories when it comes to dealing with high inflation. The first of these theories centers around raising
interest rates. The idea is that raising
interest rates would increase the flow of money back to banks. Once the money is back in the hands of the
banks, the Federal Reserve (or "Fed") gives the banks treasury bonds
in exchange for the money (which can in turn be sold back to the Fed when they
ease monetary policy in the future) bringing the money back into control of the
Federal Reserve. At this point, they can
take the money back out of circulation, reducing the monetary base (Masci).
The
second theory is that simply stopping, or slowing, the rate at which new money
is printed would gradually and, in theory, less painfully curb the rate of
inflation. Proponents of this theory
maintain that growth in economic output would eventually catch up with the
amount of money in circulation so long as the amount of money does not continue
to grow (Friedman 270-73). Basically,
what this means is that the prices of goods and services would essentially
level off, or possibly even drop if production increases, while wages would
gradually increase to match the new, higher, prices of goods and services.
The
third and final theory, while widely held. is more controversial. This theory is that higher rates of employment
mean more people with money to spend, causing demand for products to go
up. This also means that the inverse
would be true, raising the rate of unemployment means less people with money to
spend therefore the demand for products would be reduced (Laffer 239-40). This third theory is controversial for obvious
reasons. People are more hesitant to
employ this strategy because of the potential political and social fallout of deliberately
high unemployment rates, but the main premise is a widely held belief in
economic circles. Except for in very rare circumstances there is always a certain amount of inflation, and it is actually a fairly widely held belief that a low amount of inflation is even desirable, so why is it something that people should be concerned with and learn more about? If people know how inflation works, and particularly what causes inflation rates to increase, they can see the warning signs ahead of time and prepare themselves for it before it happens. The main thing the average person can do to prepare for high inflation rates is to buy ahead of time. If there is something people know they are going to have to buy in the near future, and they see inflation coming, they can buy those things now before the prices of them are inflated. That idea applies particularly well to food; food is one of the things that is hit first, and hardest when inflation rates are high, so stocking up on food when inflation rates are expected to be particularly high is a good way to prepare. There are a number of other things people can do to prepare based on their resources, but they will not know to do them if they do not see the signs of inflation ahead of time.
Sources:
Friedman,
Milton, and Rose Friedman. Free to Choose. 1990 ed. 1980. San Diego:
Harcourt Brace & Co., 1990. 253-75. Print.
Laffer, Arthur
B., and Stephen Moore. Return to Prosperity. New York: Threshold
Editions, 2010. 235-50. Print.
Masci, David.
“The Federal Reserve.” CQ Researcher Online. N.p., 1 Sept. 2000. Web. 15
Mar. 2011.
<http://library.cqpress.com//.php?id=cqresrre2000090100&type=hitlist&num=1>.
Sowell, Thomas. Basic
Economics. 4th ed. New York: Basic Books, 2011. 389-401. Print
