I’m thinking of two specific instances, one historical, one fictional. In both cases, heavy war reperations cause rampant inflation in the national economy. I was hoping some economical-minded Doper could tell me why that happens.
The historical case is in Germany in the 1920s. The fictional case is in Harry Turtledove’s book American Empire: Blood & Iron. In both cases, prices shot up well over a million fold in a very short period of time. Money was soon not worth the very paper it was printed on. In the fictional case, the inflation came to a halt when the reperations stopped.
My questions are:
How does paying severe reperations cause inflation? If I personally owed a huge amount of money, it wouldn’t cause what little I had to inflate, would it? So, why does that happen on a national level?
Is diverting a large portion of the national income out of the economy altogether (as in war reperations) the only way to trigger massive runaway inflation (I’m not talking about the relatively piddling 18% we had in the late '70s, I’m talking about the huge amounts described in the book, or as happened in Germany in the 1920s)?
That’s because you can’t print Zevdollars. Governments under very severe financial stress are often tempted to print money rather than raise the revenue required by ordinary taxes.
Other places have had hyperinflation (accelating to thousands of percent a month) and or chronic high inflation (100s of percent). Latin American countries and Israel spring to mind. The payment of reparations is not always a feature. Unresolved distributional issues, huge government deficits and massive monetary expansion (usually running the printing presses) are usually involved, although there’s disagreement about which one is the cause.
When inflation’s really going it can get pretty ugly - get stuck in the office on pay day and your pay can be worth rather less when you get off. Cacculating prices becomes a challenge - economist Anne Kruger tells a story of staying with a colleague in Israel whose wife returned very upset from the shops having paid a thousand times too much for a box of cornflakes.
In both cases, it has to do with how you’re paying your reparations.
Typically, they are payed in an outside currency. If the reperations are onerous enough they have little or nothing left over with which to actually govern the country.
What they do is print more of their own currency, and spend that to run the country.
Supply and demand is pretty simple on this point. I there is only say 100 million bucks worth of goods and services in the country to be purchased, and the government prints and spends 120 million buck in currency, than another 20 million dollars worth of stuff doesn’t just magically appear.
No matter how much money you have, you can only purchase what is actually there.
So, in this highly simplistic example, the government would have created 20% inflation.
It’s happened elsewhere without reparations involved. Argentina comes to mind.
It’s basically caused when the government prints money to pay for stuff. This pays government obligations cheaply at the expense of everyone else, and is in effect massive taxation.
Thank you for the expainations. Does this mean that inflation is impossible in a country on a strict gold (or silver) standard where every paper dollar is backed by gold/silver/precious metal or mineral of your choice?
Upon thought, if it was a 1/1 ratio with demand exchange then it would certainly not be inflation, but a devaluation of the commodity in question.
(This would be an economy that held a dollar in gold for each dollar it issued and was willing to exchange freely between them on demand)
In a more realistic sense, a standard is likely to have limited exchangeability, or costs and penalties associated with exchange. They are also likely not to maintain a 100% reserve.
In such an instance confidence becomes an issue, and depending on that and what the reserve is, and how closely it is followed, you could end up with an inflationary environment.
It makes it much harder. That’s the whole reason behind a limited commodity standard. Essentially its a tactic for putting an untrustworthy government in a fiscal straightjacket so it can’t run the printing presses to pay its bills.
The problem is that sometimes a little inflation is good. When the economy is slowing down you want the government to have the freedom to give it a little goose by pumping more money in.
Plus, you really don’t want large quantities of wealth sitting around idle as ingots of gold. You want in banks and stocks where it gets recycled into the economy. This is why the federal government was so busy buying gold during the Great Depression and hiding it away in Fort Knox – they were pushing wealth out of an idle commodity and moving it back into the banking system where it could be loaned out to businesses.
A gold standard is pointless for a modern economy like the U.S. since a large part of the “money supply” isn’t paper money at all but access to credit. Even with a constant money supply you can have inflation if people buy more and more on credit. This is why the Federal Reserve’s main tool for tuning the economy isn’t controlling the money supply but adjusting the prime interest rate which affects the interest rates of private and commercial loans, which expands or contracts the total amount of debt.
Well, the government could also switch standards to spark inflation. If you’ve ever heard of the “free silver” movement at the end of the 19th century, that’s what that was about. It was a move to switch the standard from gold to silver, in order to increase inflation to make it easier to pay back debts.
Why can’t you have both? IOW, if the government wants to be on a metal standard, and has $100b in gold deposits and $50b in silver deposits, then have $150b available in cash? As long as it’s backed by something that’s more or less universally valued, shouldn’t that be enough?
Well, that’s called bimetallism, and you can do that…the US did do that before the Civil War, but you run into problems when the value of gold and silver change with regards to each other. Here’s a website illustrating the problem:
Who cares about money? Money is what money does. If the real economy (good and services) is sustainably going well, why would you care about the value of little bits of paper?
As has been stated, the ultimate ‘value’ is having stuff to buy with the money. A certain amount of inflation promotes savings and investment; this supplies capital for expansion of business, which results in lots more stuff for the money to buy … Ideally, your fiscal policy might increase prices by (say) 1% while increasing the money supply by (say) 2%. So, people should have more money to buy the more expensive stuff with …
Because there’s a lag in the rise of prices. Increase the money supply and for a while people have more money to spend before prices catch up.
Also, devaluation of money reduces the amount of dept that individuals are carrying, since debts were incurred using the old money. That means more money to spend after paying the mortgage.