Ch. 17 Reflection: Money Growth and Inflation

Ch. 17 Reflection: Money Growth and Inflation

What are the costs of inflation?  There are many costs of inflation. In Chapter 17 we learned about the costs of hyperinflation, making money nearly worthless, so worthless, that in places like Zimbabwe, they post signs to ask people not to use it as toilet paper and flush it down the toilet. Compared to that, the US has it pretty good, as we’ve not to experience inflation more than about 7% since I’ve been alive. There is even some research that shows that some inflation is good for the economy. One of the main takeaways from reading Chapter 17 regarding inflation was the concept of the inflation tax. The book describes this as “the revenue the government raises by creating money”. For instance, ideally, the government is able to raise all of its budgets through taxes. But in some cases, like during war and with the Wall Street bailout in 2008-2009, the government resorts to printing money and thus increasing the money supply. When this happens, prices usually rise, thus creating a “tax” on the people without having to get people’s agreement about the tax. Other costs of inflation include menu costs, shoe leather costs, relative price variability, induced tax distortions confusion and inconvenience, and arbitrary redistribution of wealth.

Which is most important?  In the US, I believe that induced tax distortions and arbitrary redistribution of wealth are the most important costs of inflation. For instance, when the government creates a tax code on capital gains, they rarely factor in inflation. Therefore, not only are we taxed on gains, but we are also taxed on the inflation experience over the lifetime of the investment that we sell and pay capital gains on. A better way forward would be to subtract our capital gains from the costs of inflation and pay tax on the difference. As far as arbitrary redistribution of wealth, when unexpected rates of inflation or deflation occur, then the public can be caught off guard and owe more than they expected to owe when signing up for a loan for instance. This can cause people to default on loans and end up filing bankruptcy which can ruin their credit for years or decades to come.

How about deflation? Deflation at first may seem like a good thing when the prices of goods and services fall. However, this is generally not a good thing for those selling those products and services. For instance, if a farmer or student takes out a loan to pay for equipment or schooling and the country experiences deflation, it will make it much more difficult for the farmer or student to repay the loan when it comes due. However, a small and predictable rate of deflation can be good for the economy because it lowers the nominal and real interest rates for loans on new capital projects which spurs growth. This concept is known as the Friedman rule names after Milton Friedman.

The FRB worries more about deflation. Why? The FRB may worry about deflation because it often shows signs of “deeper economic problems”. For instance, when the country experiences deflation, it can cause money contraction, unemployment, less spending, and lower incomes. If this happens, the FRB would no longer be in perfect control of money supply and interest rates. I tend to not trust the FRB, and I am still upset how they bailed out wall street, but don’t tend to help the average American much when it comes to foreclosure or bankruptcy. When is the FRB going to bail out Americans? They can worry all they want, but I would rather them listen to the experts like Jim Rickards and plan ahead next time instead of putting out the fire after they let it get out of hand. To me, it’s like they put out the fire of the 2007-08 crises and then patted all of the bankers that caused the problem on the back. Instead, the FRB needs to send the message that the bankers cannot roll the dice and accept unnecessary risks and rely solely on insurance to bail them out. The bankers blame the public for defaulting on their loans, though they shouldn’t have been given loans in the first place.

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