INFLATION
INFLATION OR DEFLATION,
TELL ME IF YOU CAN…
WILL WE BE ZIMBABWE OR
WILL WE BE JAPAN?
INFLATION IS A GENERAL INCREASE IN
PRICES OVER TIME, OR A GENERAL
DECREASE IN THE VALUE OF MONEY
“I REMEMBER WHEN $400
BOUGHT AN ENTIRE CAR”
“I JUST BOUGHT FOUR TIRES
FOR ONLY $400”
THE MOST COMMON WAY TO MEASURE
INFLATION IS WITH THE CONSUMER PRICE INDEX
(CPI)
THE CPI TAKES A
REPRESENTATIVE
SHOPPING BASKET OF
COMMONLY PURCHASED
GOODS AND SERVICES
AND TRACKS HOW THE
PRICE OF THAT BASKET OF
THINGS CHANGES OVER
TIME.
CONSUMER PRICE INDEX
IF, IN 1920 THIS BASKET
COST $20.00 TO FILL
AND IN 2012 IT COST $200.00
TO FILL WITH THE SAME ITEMS
THEN THE PRICE LEVEL IN 2012 IS TEN TIMES WHAT IT WAS IN 1920
OF COURSE, ECONOMISTS HAVE TO ACCOUNT
FOR CHANGES IN CONSUMPTION BEHAVIOR
CHANGES IN THE
PRIORITIES OF CONSUMERS
CHANGES IN TECHNOLOGY
THE CPI DOUBLED FROM 1985 TO 2009, SO
ON AVERAGE THINGS COST T WICE AS MUCH
IF AN APPLE COST
$.50 IN 1985
ODDS ARE IT COST
ABOUT $1.00 IN 2009
A DOUBLING OF PRICES IN 24 YEARS
SOUNDS LIKE A LOT OF INFLATION
BUT IN FACT IT AVERAGES
OUT TO ONLY ABOUT 3%
PER YEAR. THE RULE OF 72
SAYS THAT WITH INFLATION
OF 3% PER YEAR, PRICES
WILL DOUBLE IN ABOUT
72/3 = 24 YEARS.
WHAT CAUSES INFLATION?
WHAT IS MONEY?
CASH
ANYTHING YOU CAN BUY
STUFF WITH
CHECKBOOK MONEY
CREDIT
LOANS
WHY DID HOUSING PRICES RISE SO
RAPIDLY IN THE EARLY 2000 S ?
LOWER INTEREST RATES ALLOWED PEOPLE TO BORROW MORE AND BID UP PRICES
HIGH LEVELS OF INFLATION IN POST
WORLD WAR II AMERICA
RATIONING, PRICE CONTROLS
AND PATRIOTISM
PENT UP DEMAND WAS
RELEASED AFTER THE WAR
DRAMATIC INCREASES IN GOVERNMENT
SPENDING CAN CAUSE INFLATION
LBJ CREATES THE “GREAT
SOCIET Y”
LBJ EXPANDS THE VIETNAM
WAR
THE PRICE INDEX IN THE LATE 1960s RAPIDLY ACCELERATED FROM THE SPENDING
INFLATION CAN ALSO BE THE
RESULT OF A SUPPLY SHOCK
THE O.P.E.C. OIL EMBARGO
IN THE FALL OF 1973
SPURRED AN 11% RATE OF
INFLATION IN 1974
SEVERE DROUGHT IN 2012 AND THE
IMPACT ON CORN PRICES
• HALF THE CORN CROP LOST
• U.S. PRODUCES 40% OF THE
WORLD’S CORN
• GLOBAL FOOD SHORTAGES
• CATTLE FEED PRICES UP
• MEAT AND DAIRY PRICES UP
• ETHANOL PLANTS IDLE
• GAS PRICES SPIKE
• HIGHER DELIVERY COSTS
THUS RETAIL PRICES
• AIRLINE TICKET PRICES UP
• TOURISM REVENUE DOWN
• HIGHER HOUSEHOLD WATER
PRICES AS MORE IS DIVERTED
FROM CIVIC USE
INFLATION IS PARTICULARLY MADDENING BECAUSE
PEOPLE SUFFER FROM MONEY ILLUSION
HAVE YOU EVER HEARD SOMETHING LIKE THIS?
$3.00 FOR A GALLON OF MILK!!!?
I REMEMBER WHEN IT WAS $.72 A GALLON
THE OLD MAN HAS COMPARED THE
NOMINAL PRICES OF MILK
BASED ON OUR PREVIOUS COMPARISON, IF WE
ADJUST FOR INFLATION, THAT $.72 GALLON OF MILK
IN 1920 SHOULD COST $7.20 IN TODAY’S DOLLARS.
THE REAL PRICE OF MILK
HAS ACTUALLY FALLEN
IT ALSO TAKES FEWER HOURS OF LABOR
TO BUY THINGS THAN IN THE PAST
IF MY WAGE WAS $.75/HR
IN 1920
ONE HOUR OF LABOR TO BUY MILK
IF MY WAGE IS $15.00/HR
IN 2012
12 MINUTES OF LABOR TO BUY MILK
INFLATION MAKES IT DIFFICULT TO COMPARE
MONEY TODAY WITH MONEY TOMORROW
INFLATION ERODES THE
GAINS FROM SAVINGS
INFLATION MAKES IT
DIFFICULT TO PREDICT PROFIT
SAVERS AND LENDERS ARE REWARDED WITH
A RATE OF INTEREST FOR THEIR RISK
5
-
NOMINAL ANNUAL RATE
OF RETURN OFFERED BY
THE BANK
3
ANNUAL RATE OF
INFLATION
=
2
REAL RATE OF
RETURN ON
INVESTMENT
THE GAINS WILL BE LESS THAN YOU EXPECTED
BUSINESSES WILL INVEST IN NEW CAPITAL OR
LABOR IF THEY BELIEVE THE REVENUE
POTENTIAL IS GREATER THAN THE COST
THE PROBLEM IS IF YOU DON’T KNOW WHAT
THINGS WILL COST, IT’S DIFFICULT TO
ESTIMATE REVENUES.
LARGE AMOUNTS OF INFLATION CAN CAUSE
SERIOUS DAMAGE TO ENTIRE ECONOMIES
ZIMBABWEAN GOVERNMENT GOES ON A
SPENDING SPREE
 PRINTED CURRENCY TO
PURCHASE FOREIGN
RESERVES AND PAY OFF ITS
DEBTS TO THE IMF
 PRINTED MORE CURRENCY TO
PROVIDE 900% PAY RAISES TO
POLICE AND ARMY
PERSONNEL
 PRINTED MORE CURRENCY TO
PURCHASE OXEN AND PLOWS
FOR THE RURAL FARMERS
 SHOPS CAN ONLY CASH
CHECKS IF THE CUSTOMER
WRITES IT FOR T WICE AS
MUCH, THE VALUE WILL BE
HALVED BY THE TIME IT
CLEARS
NOT ENOUGH MONEY IN THE ECONOMY
CAN BE EQUALLY DEVASTATING
DEFLATION
 CONSUMERS LOSE
CONFIDENCE AND STOP
SPENDING
 PRICES FALL
 WAGES FALL AS A RESULT
OF LESS BUSINESS INCOME
 CONSUMER DEBTS
INCREASE AND EXISTING
OBLIGATIONS BECOME
HARDER TO MEET
 PEOPLE CUTBACK AND SAVE
MAKING MATTERS WORSE
JAPAN
JAPAN’S LOST DECADES
 THE NATION’S EXTRAVAGANT
LIVING IN THE 1980S LED TO
THE BURSTING OF AN ASSET
BUBBLE
 THE GOVERNMENT INCREASED
INTEREST RATES TO CONTROL
PRICES
 JAPAN’S AGING POPULATION
REJECTED EXCESS AND
REDUCED SPENDING
 COMPETITION FROM OVERSEAS
FORCED JAPANESE COMPANIES
TO REDUCE PRICES
 INTEREST RATES HAVE FALLEN
BUT THE GOVERNMENT REFUSES
TO INFLATE THE CURRENCY OUT
OF DEFERENCE TO THE ELDERLY
 PRICES AND WAGES REMAIN
DEPRESSED T WENT Y YEARS
LATER
IN RESPONSE TO THE GREAT RECESSION, OUR
GOVERNMENT HAS TAKEN EXTRAORDINARY
MEASURES
BAILING OUT BANKS AND
INDUSTRIES, AND BUYING BONDS
EXTENDING TAX CUTS AND
EXPANDING WELFARE
YET THE U.S. ECONOMY HASN’T
REBOUNDED WITH ANY ENTHUSIASM
UNEMPLOYMENT IS STILL
HIGH
CONSUMER AND BUSINESS
CONFIDENCE IS LOW
WILL THE U.S. BE ZIMBABWE OR JAPAN?
WILL OUR OLD SPENDING WAYS RETURN
AND ALL OF THE MONEY GENERATED AS
FISCAL AND MONETARY RESPONSES TO
THE CRISIS FLOOD THE ECONOMY?
OR
WILL THE DEPRESSION IN THE
HOUSING MARKET AND LOW
CONFIDENCE IN THE PROSPECTS
FOR THE U.S. PLACE THE NATION
IN A RUT?