My muddy understanding is that if the number of currency units in the economy increases more than the value of the stuff they are denominating, it will take more currency units to account for each unit of stuff, and thus the price of the stuff will appear to rise. What’s really happening is that the ‘size’ of the currency units is decreasing.
I am also of the impression that central banks can create as many currency units as they want.
So why don’t they try to match the number of currency units to the amount of stuff? If there’s more stuff, add more currency units. If there’s less stuff, remove currency units.
Instead, we get the business news reporting the inflation rate in the same way that the weather news reports the temperature: as something from outside that is an immutable feature of the environment, and we’ll just have to deal with it.
The Bank of Canada website, for example, reports a desired inflation rate of something like 1.5 percent (or whatever); there’s an implication that too little inflation is as bad as too much, and that an inflation rate of zero is bad.
Obviously, depending on how accurately the powers that be perceive things, there might be undershoots and overshoots, but why don’t we try to maintain an inflation rate of zero?
1 ) Deflation is very damaging to an economy. It tends to cause to people to stop buying, waiting for stuff to go on “sale” next week as prices fall. That can quickly turn into a recession or depression. Since it is duifficult to measure, much less control, inflation / deflation accurately, better to err on the side of caution.
Many prices (particularly of labor) are very hard to reduce. People will accept no pay raise, or one less than inflation, a lot more readily than they will accept a pay cut. The same thing applies to many non-wage prices as well. As a result, a small amount of inflation is considered by many economists to act as a “lubricant” for downward price changes. If humans were completely rational economic beings this wouldn’t be so. But as long as people are emotional decison-makers, small inflation camoflages downward price changes up to the rate of inflation.
Above all, Central Banks have only very indirect controls over the economy, and all their data is estimates and several months behind current reality. In that environment, they can’t fine tune anything. All they can do is tug the reins in the general direction they wish the beast would go on its own.
In a world with no credit, no lending, no bonds, etc., where everythng was cash, they’d have a lot more direct control. That world disappeared a couple thousand years ago, long before central banking was invented.
Inflation is essentially due to the fact that the relative value of some products, commodities, or services changes at a different rate than others. This imbalance results in an exchange medium (typically thought of as money) being more available, and thus less valued relative to another item (gasoline, gold futures, entry-level labor), and this trickling through the rest of the economic sphere. In the case of monetary inflation, the supply of available money increases, which means the value of any small pool of money is worth less.
A small amount of inflation is typically considered healthy, and is almost unavoidable in a growing economy–it means that economic value is being added to the system, resulting in an increase in the money supply. Because this almost never happens across the board, some get more value than others. For instance, when the value of your AMD stock goes up (based upon the desire of other people to purchase it in the believe that AMD will continue to make good products and increase sales) the money supply increases and inflation–your ability to purchase stuff relative to your unfortunate neighbor who invested in Motorola–increases. A large or rapid cycle of inflation results in a positive feedback cycle where those with the desired assets gain money while everyone else “loses” the value of the cash in their pockets; i.e. the rich get richer, and the middle class become poor. Monetary deflation, on the other hand, results in everybody’s money decreasing in ability to purchase stuff, and is always undesirable except as a modest correction to hyperinflation.
Trying to manage inflation by printing or burning money is problematic from a couple of standpoints. First of all, the measures or indices that estimate inflation are still pretty crude and typically only look at a slice of the economy. Even the standard indices which cover many different industries and commodities are only taking a sampling and may miss small scale but influential trends, e.g. the emergence of the dot.com balloon. Second, such attempts to control the economy lag behind the indicators themselves, so instead of simplifying the situation you’ve added another non-organic feedback cycle. You’d like for it to be negative (correcting) but it’s hard for it not to become positive and destructive. Attempts to control an economy via fiat fiscal management on the detail scale have not been unqualified successes, though control of the overall monetary supply from the Fed (in the US) and the European Central Bank (in Europe) are critical–though not always effective–to preventing hyperinflation or deflation. A lack of such controls on the Pacific Rim resulted in significant problems there when economic growth hit a maturity wall, and the hodgepodge of economic controls and theories in South America have crippled the ability of some otherwise industrialized nations to compete with the Northern Hemisphere.
And the less said about Communism or dogmatic fiscal socialism the better. Government-issued price and wage controls are a risky, albeit sometimes necessary–step.
Are you volunteering your currency units to be removed? All those “currency units” belong to someone you know. In any case the central bank doesn’t have direct control over the amount of money. It would (or at least might) if all money was in the form of currency, but most money is not. Most money is simply an electronic record someplace that it belongs to someone. The central bank only indirectly controls the money supply by controlling (or trying to) interest rates. Those determine, amongst other things, how willing we all are to keep out money as cash or earning interest. Though these days I’d say the convenience of money on deposit for direct payment of things on line, etc. probably outweighs interest benefit.
The economy is a conglomeration of literally billions of economic decisions, made simultaneously and continuously. Using the printing press to try to control the economy is like trying to control the flight of a jumbo jet full of passengers by swatting it with a giant badminton racquet.
To grotesquely oversimplify what I remember from Econ101 (a class I took many years ago), inflation and employment go hand-in-hand.
When you try to make one problem better, you have to be cautious, lest other problems get out of hand.
On the one hand, if you try for zero inflation, unemployment will skyrocket.
On the other hand, if you try for full employment, inflation will skyrocket.
I forget whether it was Truman or Eisenhower who said he wanted to find a one-armed economist.
So private banks create money. Although I prefer to think of it as borrowers creating money. When you take out a loan, you are effectively promising society as a whole that you will create that amount of wealth. If the bank believes you, that is if you are creditworthy, you will get the brand new money.
Yes, but the Central Bank can indirectly control how much money the banks lend out(and thus how much money is being created in the economy) by setting things like interest rates and reserve ratios.
Employment and inflation are tied together with the rope of economic growth. When you take a screw and some plastic (costing $4) and smack it together to make a toy which you sellf or $15, you’ve just caused inflation. If we aimed for 0 inflation, then you’re asking everyone to stop making 1 and 1 into 3. You know what happens then…everyone gets fired.
The actual reason why you have to have inflation is that fungibility has intrinsic value.
That’s the simple answer, and the complete answer. I’ll explain it a little more though.
Let’s say you have a pig and you need a sweater. In order to get your sweater you need to find somebody with a sweater who needs a pig and work a swap. Rather than spending months tracking down sweater bearing porcine afficionados it helps to have a medium of exchange.
A good medium of exchange is a fungible asset. A fungible asset is an asset which is as good but no better than any other of it’s kind. Gold of a specific purity is an example of a fungible asset. Gold though, has other uses and at times those values may exceed its fungibility value corrupting it as a medium of exchange.
Currency has no other use but for its fungibility. One dollar is as good as any other dollar. No dollar is worth more than any other.
This fungibility is very valuable. This gives dollars inherent worth since they can be traded for literally anything. This value would cause people prefer them to other assets since a dollar would be better than anything else since it can be exchanged for anything else. Without inflation, dollars would be hoarded for this value.
In order to keep a liquid market that value has to be extracted to maintain the fungibilty (that dollars are not particularly valuable over their worth in something else.) That value is extracted by inflation.
Let’s say the government takes in $100 and they print $103. They make a profit of $3. Inflation is 3% in this simplistic scenario. People don’t hold onto their dollars as much because they know they will lose 3% per year if they do. They exchange them for other services. The inflation here provides liquidity to the market preserving fungibility in the medium of exchange.
If the government doesn’t extract this value others do.
“Currency units” is only one of the several cause of inflation, and except in weird economies, it is hotly debated whether or not it is a major cause. Here is a loooong wiki quote.
"*Causes
There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation, and quantity theories of inflation. Many theories of inflation combine the two. The quality theory of inflation rests on the expectation of a buyer accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.
Keynesian economic theory proposes that money is transparent to real forces in the economy, and that visible inflation is the result of pressures in the economy expressing themselves in prices.
There are three major types of inflation, as part of what Robert J. Gordon calls the “triangle model”:
* Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc.
* Cost-push inflation: presently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.
* Built-in inflation: induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black Plague.
The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics, by contrast, typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians the money supply is only one determinant of aggregate demand. Some economists consider this a ‘hocus pocus’ approach: They disagree with the notion that central banks control the money supply, arguing that central banks have little control because the money supply adapts to the demand for bank credit issued by commercial banks. This is the theory of endogenous money. Advocated strongly by post-Keynesians as far back as the 1960s, it has today become a central focus of Taylor rule advocates. But this position is not universally accepted. Banks create money by making loans. But the aggregate volume of these loans diminishes as real interest rates increase. Thus, it is quite likely that central banks influence the money supply by making money cheaper or more expensive, and thus increasing or decreasing its production.
A fundamental concept in Keynesian analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggests that there is a trade-off between price stability and employment. Therefore, some level of inflation could be considered desirable in order to minimize unemployment. The Philips curve model described the U.S. experience well in the 1960s but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.
Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so the trade-off between inflation and unemployment changes) because of such matters as supply shocks and inflation becoming built into the normal workings of the economy. The former refers to such events as the oil shocks of the 1970s, while the latter refers to the price/wage spiral and inflationary expectations implying that the economy “normally” suffers from inflation. Thus, the Phillips curve represents only the demand-pull component of the triangle model.
Another Keynesian concept is the potential output (sometimes called the “natural gross domestic product”), a level of GDP, where the economy is at its optimal level of production given institutional and natural constraints. (This level of output corresponds to the Non-Accelerating Inflation Rate of Unemployment, NAIRU, or the “natural” rate of unemployment or the full-employment unemployment rate.) If GDP exceeds its potential (and unemployment is below the NAIRU), the theory says that inflation will accelerate as suppliers increase their prices and built-in inflation worsens. If GDP falls below its potential level (and unemployment is above the NAIRU), inflation will decelerate as suppliers attempt to fill excess capacity, cutting prices and undermining built-in inflation.
However, one problem with this theory for policy-making purposes is that the exact level of potential output (and of the NAIRU) is generally unknown and tends to change over time. Inflation also seems to act in an asymmetric way, rising more quickly than it falls. Worse, it can change because of policy: for example, high unemployment under British Prime Minister Margaret Thatcher might have led to a rise in the NAIRU (and a fall in potential) because many of the unemployed found themselves as structurally unemployed (also see unemployment), unable to find jobs that fit their skills. A rise in structural unemployment implies that a smaller percentage of the labor force can find jobs at the NAIRU, where the economy avoids crossing the threshold into the realm of accelerating inflation.
*
There are also SIX more theories lower down the page.
Your concept is (at best) over-simplistic and only part of the problem. Don’t get me wrong, at some points in history it seems like “printing more $$” is exactly what caused run-away inflation. However, IMHO it has little effect on the normal low rates of inflation we see nearly every year.
If that’s true, then how do you explain the success of inflation targeting programs by various central banks? If inflation were not a primarily monetary phenomenon then how could monetary policy control it so effectively?
I wasn;t talking about Inflaion, I was talking about the OP’s idea that Inflation is caused entirely by "the number of currency units in the economy". ie *"My muddy understanding is that if the number of currency units in the economy increases more than the value of the stuff they are denominating, it will take more currency units to account for each unit of stuff, and thus the price of the stuff will appear to rise. What’s really happening is that the ‘size’ of the currency units is decreasing.
I am also of the impression that central banks can create as many currency units as they want."*
Did you read my cite? Are you a Keynesian? A follower of Hume & Smith? Read that cite, and a couple other good books on Econ 101, then get back to us. Really, the actual causes of inflation at the macro level are beyond us mere mortals, anyway.
Could you give an example of where wage and price controls were necessary - and actually worked?
Wage and price controls are about the worst way to attempt to control inflation possible. Every time they are tried they lead to economic distortions, black markets, and unintended consequences far more severe than the inflation they were attempting to curb.
Wage and price controls keep rearing their ugly heads because they are a quick, populist ‘solution’ do a difficult problem. People are screaming for rent controls here in Alberta right now, and politicians are listening, despite the abject failure of rent controls pretty much everywhere they’ve been tried. We haven’t got them yet, but I wouldn’t be surprised if we did. And I’m certain that they’ll be a disaster.
Fine, then *you *explain it. Please. I am serious. I don’t claim to understand it, all I know is that it’s a very complicated subject and can hardly be explained by something as simple as “the number of currency units in the economy”. But maybe I am wrong, so tell us, inform us- Do you think that inflation is caused solely by "“the number of currency units in the economy”? *Is *it that simple?
Wage controls in the Early 'Seventies kept the U.S. economy from going entirely into the dumpster while substantial increases in the trade deficit (especially oil) began and the Bretton Woods international fiscal management system was dismantled. Without the wage controls, massive depreciation of the dollar due to the U.S. falling off the gold standard and running a standing trade deficit would have devestated the U.S. economy. As unpopular as these were, they provided a buffer against largely negative response (especially from organized labor) which would have likely had extremely negative impact upon the economy as a whole.
Of course these were, and were always intended to be, very short term measures, and even the advocates of them realized that there would be negative fiscal and political consequences. In general, I completely agree with your assessment of fixed wages and price controls with regard to the functioning of an otherwise healthy, robust economy. One can see what effect wage controls and the experiment of planned economic management had on post-war Great Britain, which along with the loss of colonial trading “partners” to exploite, eviscerated the manufacturing capability of the once mighty industrial giant of Great Britain. Between the two Britain became the economic joke of Europe.
Rent controls are actually a great example; the city of Santa Monica tried to institute rent control about a decade or so ago, with the intent of making rental housing affordable. The result is that owners decided to stop renting property and sold it as condos instead, crashing the rental market and amping up property values to the point that only the very well off could afford to buy. Talk about cutting off one’s nose to spite one’s self.
But totally unlimited laissez faire capitalism tends to result in an economic stranglehold by a few interests, and when shifting economic conditions undermine the areas of those interests (i.e. in Japan in the 'Nineties) the whole economy goes in the shitter; never mind the deliberate corruption of companies like Enron, Worldcom, Tyco, et cetera and the resulting damage that does.
No, that is not an example of inflation. It is an example of adding value. Knowing how to make something and taking the time to make it both have value that can be compensated. Thus, a finished product is worth more than the sum of the value of its components.
Inflation is how the value of money changes over time. If next year, our toymaker decides the toy is should sell for $16 because each dollar is worth less–that is inflation. If he raises the price because there’s a shortage of toymakers–not inflation.
One book I read, don’t remember the name, said that inflation was the result of invention. The cost of goods went up because of the invention of new goods.
Read that cite, and a couple other good books on Econ 101, then get back to us. 
Really, the actual causes of inflation at the macro level are beyond us mere mortals, anyway.
