[galaxyLogic]

If inflation is caused by people having too much money then it is a self-correcting problem because as prices go up people will no longer have as much money. Soon enough they will not have too much money at all.

So what is the real problem with inflation? Is it the economic inequality it brings to those who have to live on fixed income?

I've been following the discussion on US TV and it seems they are saying we need more unemployment. We need economic hard time so that people will not have too much loose money any more. We need more unemployment so that employers don't have to pay bigger wages causing wage-inflation.

To me this sounds counter-intuitive. How can the solution be more unemployment? People will then have even less money after paying the grocery and gas-bills.

[arc-in-space]

(Much has been said in the other comments, but I find them mostly incomplete)

> If inflation is caused by people having too much money then it is a self-correcting problem because as prices go up people will no longer have as much money. (...) So what is the real problem with inflation?

Great question. The "real problem" with inflation depends on what type of inflation it is - either demand side, which is what the Fed can control, or supply side, in the form of rising energy or food prices due to external shocks. Right now we actually have both. The latter directly worsens standards of living (it causes prices to rise but wages stay the same), and the former is a bit more subtle; it taxes savings and causes various instabilities through the economy due to the changing value of future money, such as eroding the value of a loan for borrowers. (But in the long term prices and wages do re-adjust, as you point out; the problem is short term.)

> I've been following the discussion on US TV and it seems they are saying we need more unemployment.

The TV is hopelessly confused. We do need a monetary tightening to stop the economy from overheating(demand-side inflation), which will unfortunately worsen unemployment, but that isn't the main mechanism here. The inflation is a consequence of a mistake that has already been made by the Fed - overly expansionary monetary policy since 2021 - and the steps required to fix it will cause unemployment to temporarily rise.

And yes, this is going to suck. But the more the Fed waits, the worse it gets.

[BoiledCabbage]

You were right, up until you were wrong.

Most peeps looking at this situation ignore (or are unaware) of the first level issue. It's it demand side or is it supply side. Demand side can rebalance eventually and is less harmful. Supply side means everyone is now poorer and it's more painful on top of also including a unequal distribution of that pain.

The 1970s was supply side - driven most significantly by the fallout of the oil shocks.

> The inflation is a consequence of a mistake that has already been made by the Fed - overly expansionary monetary policy since 2021

However you miss the next important level of distinction in inflation. Inflation in what? Basic goods and services or investments/ assets?

People have been claiming that the Fed's policy (and QE) would kick off horrible inflation in goods and services now every year since 2009 and it never happened. When did goods and services inflation start? During the supply side shutdowns of Covid when hundreds of economies worldwide began producing less due to people remaining home, getting sick, retiring early, dying and factories and shops closing.

Then goods and services inflation kicked into high gear with yet again the oil spike. Oil price doubled in roughly 18 months, peaking earlier this year. And yet again we see goods and services inflation.

The inflation that's hitting common families is (as usual) supply driven.

Now is you're a crypto investor, or a real estate investor, or looking to buy a house, or own stocks, then yes you have legit complaint about the demand driven asset bubble and subsequent popping due to the Fed's policy of cheap money. But the reason trips to the grocery store, filing up a tank, and every day costs are more expensive now is due to supply side.

[arc-in-space]

It... sounds to me like you're agreeing? What you're describing in the second part of your post is exactly what I mean by supply side inflation. What's your issue with what I said?

[credit_guy]

I'll step in with a disagreement: CPI is a fact. The attribution to CPI to demand and supply is just a theory. And it's not all that relevant anyway.

The Fed has a job to do by law. Who cares who or what caused the inflation? Powell explains after each FOMC meeting that inflation is bad for the economy, and in order to have a healthy economy the inflation has to be reduced back to reasonable levels, around 2%. And the Fed will raise rates and keep them there until inflation is tamed.

He admits that there's supply side, but he repeatedly said the Fed can only control the demand side, and that's what they are doing.

[arc-in-space]

I don't particularly disagree with any of this from the perspective of the Fed, but that is a different discussion entirely - the distinction *is* crucial for the purpose of answering the original question of 'how is inflation bad'.

[jnwatson]

Inflation isn’t caused by too much money. It is caused by too much money velocity. That’s why the last huge injection of money in 2008 didn’t cause inflation. Folks sat on their money and didn’t spend it.

Raising interest rates isn’t about causing unemployment (directly at least). It is about causing capital investment to be less lucrative than tying the money up in treasuries, reducing money velocity.

[rogersnm]

> It is about causing capital investment to be less lucrative than tying the money up in treasuries

Money isn't tied up in treasuries, money (loosely bank deposits and cash) and treasuries are two distinct concepts. You can trade money in exchange for treasuries, but then the previous holder of the treasuries has the money, and you have the treasuries, it doesn't tie the money up.

The amount of value captured in treasuries is a function of the total government debt outstanding, and a way to increase that value is to issue more Government debt (in which case, the money goes to the Government to then spend, it still isn't tied up), however the Government is actually disincentivised to do this as their cost of borrowing (interest rates) goes up.

> That’s why the last huge injection of money in 2008 didn’t cause inflation.

The "injection of money in 2008" (the creation of central bank reserves) didn't cause inflation because the overall quantity of broad money still fell over that time period (https://fred.stlouisfed.org/series/DDOI07USA648NWDB). This was because of the "credit crunch" occurring at the time, where commercial banks where massively reducing their lending activities. The same is not true now, the creation of additional central bank reserves in the past 2 years has directly translated into more broad money, and we have inflation as a result.

[bloodyplonker22]

In addition, here's one big difference: the Biden Administration printed 1.7T worth of handouts, which was mostly spraying helicopter money directly to the people. During the financial crisis of 2008-2009, TARP was not mostly helicopter money given directly to the people. It was given to institutions, so it was much more indirect. With the Biden Administration's money spraying, a good amount of that taxpayer money went to covid relief scammers.

[didibus]

I'll try to give you the most charitable read, but even if I do, the simple fact that inflation is happening world wide seems like there's no way the cause can simply be what you said.

It also ignores the flip side. COVID relief packages have also helped in many ways, it's unclear what outcome is worse, current inflation or what else would have happened without that assistance.

Finally, I tried to do some fact checking, and what I found is that Trump actually provided even more handouts, 2.2 trillion in COVID handouts through the Cares ACT under Trump, while Biden only provided 1.9 trillion as part of the American Rescue Plan.

And if you look at the direct payments of those plan, Trump totalled 459 billion in direct handouts, and Biden totaled 402 billion.

So Trump actually gave more Covid handouts than Biden did.

Now the argument that COVID handouts might play a role in the inflation is okay, maybe it does a little, but your singling out of Biden seems biased partisanry, and it makes it even harder for me to take you in good faith.

[makomk]

While you're right that this was bipartisan, worldwide inflation could well have been least partly the result of the US government handing out too much money. Here's how: the US actually had the highest inflation in the G7 until earlier this year. In order to get that under control, the Fed has been hiking interest rates more aggressively than the rest of the developed world. This has caused other currencies to lose value against the dollar, increasing the cost of imported goods priced in dollars like oil and gas and driving up inflation elsewhere: https://edition.cnn.com/2022/08/07/investing/strong-dollar/i...

The US dollar's status as the world's reserve currency has strange and counterintuitive effects like this which make their screw-ups everyone else's problem.

[rogersnm]

> This has caused other currencies to lose value against the dollar, increasing the cost of imported goods priced in dollars like oil and gas and driving up inflation elsewhere

If I have Pounds (GBP) and I need to buy Oil and settle in Dollars (USD), I exchange my Pounds for Dollars, and then I exchange my Dollars for Oil. The price of the Oil in Dollars doesn't matter to me, only the overall price of the Oil in Pounds. It has no effect on how many Pounds I spend if the GBP:USD is weaker now than it was 1, 2 or 5 years ago, it only matters what the net GBP:Oil exchange rate is.

The only time strengthening/weakening of the Dollar can have an effect is if the price moves between the two exchanges, but given how short settlement windows are, this is somewhat irrelevant.

In a system of free-floating exchange rates and absent of supply side shocks, inflation is entirely a domestic phenomenon. The reason why the entire G7 have the same problem is because they all experienced the same pandemic, and their respective Central Banks all took the same action (to increase the money supply).

Foot notes:

[1] We have since layered a supply-side shock on top of this, which has pushed up energy prices in many currencies, but this is not because of the strengthening of the Dollar, it is because many nations wish to minimise the amount of Oil & Gas they buy from one of the largest exporters of said Oil & Gas, effectively reducing supply.

[2] A strong Dollar can cause problems when foreign nations borrow in Dollars (i.e. they borrow Dollars rather than their domestic currency). As the Dollar strengthens, this means they have to sacrifice much more of their local currency to repay the debt, which can cause significant problems. (Editors note: try not to borrow in someone else's currency if you can avoid it.)

[nostrademons]

The reason inflation is happening world-wide is because all major governments are following roughly the same policies. They all gave various forms of financial assistance to their citizens to get through the lockdowns. They also all held interest rates down, below their natural levels, to stimulate economic growth during the recovery. Except for Turkey and Russia, most of them are starting to raise rates again now that the U.S. is.

There's a competitive aspect to central bank policy: if the U.S. drops rates but other countries don't, their exports become more expensive and hence relatively uncompetitive in the world market, their manufacturing sector loses jobs, and they get thrown out of office. If the U.S. raises rates but other countries don't, their currency drops in value relative to the USD, their imports become more expensive, this fuels inflation in their home country, and they get thrown out of office. Therefore there's a strong impulse to mimic U.S. monetary policy. This also makes the reaction of other countries a constraint on the actions of the Fed; they cannot make changes willy-nilly without causing severe dislocations to the global economy.

You're right that this is not a Biden vs. Trump issue, and that Trump also pursued policies that were highly inflationary. This is a "humans are predictably irrational" issue. They nearly always pursue policies that fix the problems they have now, even at the expense of causing problems that are highly likely to occur later.

[didibus]

I think I have a bit of an issue with your overconfidence on this.

There's no proof of this it seems, while I agree it's one of many hypothesis, I find it crazy that you can jump from the hypothesis to conclude it's true just like that.

How do you simply dismiss all the other possibilities and compounding factors? There was a never seen before global pandemic, there was major disruptions in production and sourcing of goods, there was a major attrition and rotation of the labor force, there's the conflict with Russia, there were dramatically overvalued stocks, there was a trade war, there was a ton of people that died, etc.

I'd be suspicious of anyone who claims they just know the truth here, follow your guts isn't a proven way to determine what's really happening. I need some more proof, a simulation model, some actual experiments, etc.

The intuition of experts is often more likely correct, but economists are very divided here, to me it still feels like we don't know the cause of the inflation, we don't properly understand why it's happening and how to fix it.

Another aspect that's also been bothering me is that it isn't clear if inflation is a problem or not. Say it was caused by too much money having been injected, ok prices go up, but everybody has extra money, so it evens out, and doesn't really mean anyone is worse off.

Inflation doesn't really seem like it necessarily implies people are worse off, especially from the point of view of: would that person had been worse off if they'd have been evicted from their home during the pandemic and lost their job and not been given out support? Or are they worse off having had that help to make it past that and now have to deal with some inflation?

Especially assuming the inflation is due to increase money supply.

Like I just feel the actual effects of inflation are also not clear.

If inflation is driven by a loss of jobs, lack of goods, and difficulty sourcing materials, that's bad, even ignoring the inflation that's bad. If inflation is caused from too much money but there's still enough jobs, goods, and sourcing is easy and cheap, is that bad?

[JackFr]

There is also the the contention that the huge injection of money went into assets rather than goods and services, leading to asset price inflation - that is, an asset bubble - rather than elevated consumer inflation.

[TheOtherHobbes]

Inflation is mostly caused by two things. The first and most obvious are external commodity supply price shocks which crash demand because essential inputs and their dependent outputs become unaffordable. (The demand is still there of course, but it becomes too expensive to satisfy it.)

The second is misdirected money supply which steers money towards sweatable assets like property and stock ownership, and away from productive investment, original invention and research, and small business creation.

Effectively this causes an internal supply shock which raises the prices of the sweatable assets for the ownership class and impoverishes everyone else, to the point where essentials like housing become unaffordable and demand starts to seize up. Small businesses are forced to close rather than being encouraged to open.

Inflation has very little to do with money velocity, interest rates, unemployment, wage rises, or any of that other supply side nonsense.

[rogersnm]

> The second is misdirected money supply which steers money towards sweatable assets like property and stock ownership, and away from productive investment, original invention and research, and small business creation.

You appear to be arguing that an increase in the money supply for "sweatable assets" comes at the cost of a reduction in the money supply for everything else. If this were true, you'd expect inflation in "sweatable assets", and deflation elsewhere, which is not what's observed (we currently have inflation in consumer goods, and if anything, housing & stocks are deflating).

> Inflation has very little to do with money velocity, interest rates, unemployment, wage rises, or any of that other supply side nonsense.

It seems to be a substantial leap to suggest that inflation has little to do with interest rates, given that Central Banks are tasked with managing inflation, and the main lever that they pull on are interest rates. A more typical view is that, in the long run, inflation depends on the quantity of money, and interest rates affect that quantity.

[galaxyLogic]

I can see the logic behind raising interest rates to fight inflation. I can choose to buy a new bicycle today, or put the money to bank. If interest rates are higher I am more likely to put the money to bank for later consumption. I will not buy the bicycle this year, which reduces the demand for bicycles this year and thus their price goes down or at least does not rise.

But, inflation is also caused by lack of supply. How do we get more supply? By people starting businesses. But in order for them to do that they must get a cheap loan. But Feds have raised the rates so they can not get a cheap loan and thus do not start a new business and thus supply does not go up.

So Fed increasing rates would seem to help with demand-side inflation, while increasing supply-side problems. But demand-side inflation will fix itself, when things cost more people will spend less. So why is fed raising interest rates?

It's starting to look to me like inflation is a political problem. When things cost more people get angry and are less likely to vote for those currently in power.

[tkk23]

I would rather say it's money throughput, not velocity.

Higher interest rates also lead to less borrowing which reduces the volume of available money. Together with the reduced velocity, this leads to an overall reduced throughput.

That said, why is money velocity, or throughput, reduced when inflation itself is a self-correcting problem?

[c7b]

Monetary velocity is defined as the price level times real output over the money supply. There is a mechanical relation with inflation (which is the delta of the price level), but saying that's a unidirectional casual link is a disingenuous interpretation.

[makomk]

This isn't just some weird game with definitions, though, I'm pretty sure it has actual consequences that are important for understanding inflation and the cost of living crisis.

Currently, energy prices have been going up due to an inadequeate supply of fossil fuels and an excessive supply of money (especially outside the USA, with natural gas prices particularly high). This is a direct consequence of too much money chasing too little supply; it's not possible to set a lower price because more would be purchased at that price than is actually available. However, all the money people are spending doesn't just disappear but ends up as profits for fossil fuel producers, and particularly in Europe there's been a push to fix this by placing windfall taxes on producers and using it to subsidise consumer prices. The problem is that although the money doesn't disappear, the fuels bought with it have gone up in smoke, so if you distribute that money back to consumers you're effectively increasing the amount of money they have to spend chasing the same limited supply of fossil fuels just like if you outright printed money. In a sense, monetary velocity is the supply of money.

[thrown_22]

So why not go for the even simpler solution of forcing everyone to use checks which only clear once a week?

If money velocity causes inflation forcing people to use less efficient methods of exchanging money should stop it.

[refurb]

Because people will compensate and take out more money.

[thrown_22]

It's almost like velocity of money doesn't exist or something.

[extrememacaroni]

So inflation is caused by having too much crap available to buy?

[littlestymaar]

“Money velocity” doesn't really exist though except as a catch-all variable in monetarists' equation MV=PQ.

[imtringued]

The actual circulating money supply is also unknowable because you don't know if people are holding onto cash or checking account deposits for buying things in the short term or as savings for the long term. Both look identical but one of them circulates more than once per year while the latter circulates less than once per year.

It is not like we are sending a dollar bill through the economy and counting how many times it changes hands to estimate the money velocity.

If you could neatly split up the money supply into "medium of exchange" and "store of value". You could actually estimate inflation based on that equation.

[littlestymaar]

Exactly.

[pcai]

spot on about money velocity.

in addition to capital investment there's also a lot of impact by manipulating current consumption that responds to interest rates - like the housing market, which is mostly consumption.

[neilwilson]

Inflation is never caused by there being 'too much money'. It's caused by people spending and choosing to pay the higher prices on offer, rather than shopping around, saying 'no deal' or saving.

A $100 in a drawer can't cause inflation. It's not a stock problem; it's a flow problem.

Inflation is always, everywhere, a lack of effective competition. In situations of excess supply you have very little to no inflation. Firms are too scared to push prices for fear of losing market share.

We don't need hair shirt people going around confiscating assets from people. What we need is more investment to create more capacity to supply, and anti-trust action in any areas where a monopoly has arisen.

We don't need an Office of Budget Responsibility, we need an Office of Price Competition.

The target should be to maintain leptokurtic turnover vs price curves in all markets. Then we'll have stable prices.

[rogersnm]

> It's not a stock problem; it's a flow problem.

It's arguably both a stock problem and a flow problem (MV = PQ). If the stock is constant and the flow increases, you get inflation. If the flow is constant and the stock increases, you get inflation.

> Inflation is always, everywhere, a lack of effective competition. In situations of excess supply you have very little to no inflation.

Excess supply at a given price level almost by definition means prices should trend downwards (it is price that ultimately balances supply and demand, and therefore it is too high a price that causes the relative excess of supply/lack of demand).

The price of commodities around the world is going up, by definition this cannot be due to a lack of competition - there must be something else at play.

[marcosdumay]

What is missing from every discussion like this are the constraints over V.

AFAIK, nobody has ever managed to formalize any. Economists either imposed them by definition and let it float freely... Yet, the thing is very clearly highly constrained on practice. So the flow volume (MV) is somehow highly dependent on M, but not completely defined by it.

[neilwilson]

"Excess supply at a given price level almost by definition means prices should trend downwards"

Excess capacity to supply doesn't mean there is excess supply. Supply is restrained due to lack of demand.

With excess supply capacity, Firms don't generally run at full output unless there are orders to fulfil. But that doesn't mean they can't then ramp up if the orders come in.

It's when capacity to supply is exhausted that we get price inflation.

"The price of commodities around the world is going up, by definition this cannot be due to a lack of competition - there must be something else at play."

If prices are going up there is a lack of capacity to supply, therefore there is insufficient supply which is why prices are going up - to eliminate demand.

At root the shortage of energy feeds into everything else.

There is no competition. No supplier gets a 'no deal' bid to their offer. They can sell everything they can make at the price they set.

[CraigJPerry]

>> If the flow is constant and the stock increases, you get inflation

That seems like it’s missing a variable to describe when increased supply is spent vs when it is saved.

If stock increases but is not channeled through flow, i.e. i take a loan at 2% to save in my bank’s savings offer of 5.25% then flow stays the same (i still spend on the same things each month) but money supply went up and inflation remained uninfluenced by my activities as supply slowly regresses to almost prior state while i pay off each month. Not quite prior stage because i get to save the extra from interest rate arbitrage.

[rogersnm]

I think you can decompose stock into 'money that is in circulation', and 'money that is not'. In some sense, the only relevant partition is the quantity of money that is actually in circulation. If I take $100bn of cash and bury it and hide the map, I haven't actually decreased the quantity of money (the total amount that exists), but I have effectively decreased the quantity of money (the amount that is in circulation).

> i take a loan at 2% to save in my bank’s savings offer of 5.25% then flow stays the same (i still spend on the same things each month) but money supply went up

Arguably the quantity of money the bank has created for you depends on the bank's net lending to you, so if you borrow money but hold it at the same institution, you haven't really increased the money supply at all.

[CraigJPerry]

> In some sense, the only relevant partition is the quantity of money that is actually in circulation

Yeah thats the bit i’m trying to get my ahead around. Specifically:

>> It's arguably both a stock problem and a flow problem

I’m thinking the key variable here is flow

>>> it's a flow problem

You cant have inflation without increased flow, but i’m still wondering about stock because it’s not as simple as just excess money.

Perhaps it is correct enough to just frame it as a flow problem, since that variable is always dominant in every inflation scenario.

> depends on the bank's net lending to you

Yeah that makes sense, so my example should have been a loan from one bank and a savings account at another

[neilwilson]

Given that money is just a promise there are endless money things as well.

We can't define money, we can't define velocity, prices are all relative and what is included as a transaction depends on the definition.

The naive QTM is overly abstract. All we can really do is address the root cause - insufficient supply and competition.

[imtringued]

The entire concept behind a demurrage currency is to turn paper currency(and demand deposits) into money that always circulates and certificates of deposit into money that never circulates.

When you do that, then you can control inflation simply by controlling the supply of paper currency. Like the monetarists suggested.

[neilwilson]

Yet the crypto stable coins with that two part design fall apart.

Why? Because you can discount a CoD into a derivative that also then circulates.

Which is essentially what a bank does - but with a much wider selection of assets.

Eventually you realise that the solution is to embrace Full Liquidity and use a powerful buffer stock offset mechanism to create price stability.

[roenxi]

> So what is the real problem with inflation? Is it the economic inequality it brings to those who have to live on fixed income?

1) Humans aren't perfectly rational. A lot of people who don't understand exponential curves will end up going broke - like people who earned money and "saved" it by storing it in a bank account. To put it bluntly, a bunch of old people will be left destitute despite working hard and saving.

This also affects wage earners who aren't keen negotiators. They'll quickly end up with a below-market wage and might not realise what is going on.

2) Price signals take time to propagate because the economic hive mind doesn't move at the speed of light, it moves at the speed of takes-a-few-months. There will be wild mis-allocations as people work out how to measure goods in something reliable that isn't dollars.

3) The new money has to start somewhere, that group will get a massive advantage in allocating resources. They probably aren't good at it, because if they were they wouldn't need free money, so they'll cause massive waste.

4) Triggering high inflation is bad strategy for making things better, so if it is being used the people running the show are probably not the most competent of chaps. They'll be making a lot of mistakes. Eg, usually a high-inflation strategy will get coupled with other tricks to destroy savings - think gold confiscation or wealth taxes - as people try to respond sanely to money printing. If you run the numbers on how capital gains tax interacts with inflation you have a "hey! wait a minute..." moment if you like saving money.

[nostrademons]

It's not really self-correcting. When a consumer spends their money at inflated prices, it doesn't disappear. It goes to the business owner, who just received inflated prices for their goods. They, in turn, usually need to pay their suppliers, who can charge them inflated prices and make all their windfall profits disappear.

In my view, the main problems with inflation are:

1. It introduces a transaction cost tax. Every time a business raises prices, they need to spend time re-printing menus, marketing materials, websites, etc. They need to spend time renegotiating contracts. They need to re-figure their cost structure, and see if it still makes sense to use the same suppliers.

2. It disincentivizes long-term investment or planning over short-term consumption. If money's going to be worth less later, spend it now, regardless of whether you need what you're spending it on. Any long-range plans or savings will likely be invalidated by changing cost structures anyway.

As a concrete example, in times of high inflation the rational thing for an employee to do is to completely ignore their actual work and spend all their time focusing on getting a new job. Existing employees usually fall behind inflation, because they aren't actively negotiating their labor contracts and usually have no negotiating leverage anyway. The folks who make it up are those who job-hop. There is some employer out there willing to pay more than your current one; go find them, ask for 20% more than your current salary, and reap the windfall.

But if everybody does this, no actual work gets done, exacerbating any supply shortages. People become so incentivized to chase higher dollar values that they don't pay any attention to what those dollars represent.

[galaxyLogic]

> It goes to the business owner, who just received inflated prices for their goods. They, in turn, usually need to pay their suppliers, who can charge them inflated price

The first business receiving inflated prices does not really affect what their suppliers are charging them does it? When a business makes more money and if there is competition they can afford to sell at a lower price and still make profit. And they can invest in making production cheaper which will eventually decrease prices, one could think.

Good points about why inflation is bad. I was just wondering if it is self-correcting problem then it can not be very bad. It seems like a complicated problem. Except supply-side inflation is easy to understand.

[nostrademons]

It does affect them, but in non-uniform ways. Basically if you are the only one of your supplier's customers that is making more money, you can pocket the windfall as profits. If all of your supplier's customers are making more money, your supplier raises their prices to capture that (modulo the existence of their competitors that might compete to hold prices down). If some of your suppliers customers are making more money and some aren't, or if your supplier has competitors that are willing to underbid them, you split the difference.

Take a look at Bay Area home prices & inflation for a consumer example. When only startup founders were making multi-million-$ payouts, the price of homes remained reasonable. When everyone started making multi-millions, the price of homes rose to multi-million-$ levels.

Inflation, by definition, means that everybody or at least a large segment of the population has more money, so it's closer to the second scenario. The non-uniformity of competition dynamics is part of why some people reported 50% raises in 2021 but other people got nothing, though.

[bfung]

> it is a self-correcting problem because as prices go up people will no longer have as much money.

It’s not as simple as that, and thinking about the second and third order follow-ons is important. History has taught us it goes something like this:

    1. People have more money, so the majority spend it (instead of saving it).

    2. Companies, seeing more demand, but can’t expand supply as quickly, raise prices.

    3. People are feeling good cause their companies are doing well, but wait… we should get a raise and get some of that profit!

    4. see #1.

At some point, this cycle gets out of control and we finally realize “inflation is too high”.

For example, when companies can produce a good at a rate X, they can up prices at rate 1.05X. But suddenly, they run out of resources and can only produce at constant, instead of rate X, but continue to raise prices due to “projected” demand.

You have to break the cycle somewhere, and it’s painful no matter where you start, from unemployment or raise taxes or add regulations.

The US Fed only has 1 tool out of the 3, as congress is the ones with power to raise taxes or add regulation.

[saghm]

> For example, when companies can produce a good at a rate X, they can up prices at rate 1.05X. But suddenly, they run out of resources and can only produce at constant, instead of rate X, but continue to raise prices due to “projected” demand.

> You have to break the cycle somewhere, and it’s painful no matter where you start, from unemployment or raise taxes or add regulations.

I know your explanation is simplified, but as you describe it, it seems like the obvious solution is to just stop raising the prices? I feel like there must be something more complicated at play, because "we need more unemployment so that the companies don't have to stop raising their prices due to incorrect predictions" is ridiculous.

[rembicilious]

It seems like capping prices would cap inflation, but I can’t think of any great mechanism to accomplish such a cap. Central bank interest rates and taxes are controlled by relatively few people. Prices are controlled by hundreds of thousands of people.

[rogersnm]

If you cap prices for a given company or product, you prevent that company (or producers of that product) from competing effectively for the inputs to that product in the broader market place (bear in mind things like labour and energy are relatively interchangeable between companies), that can ultimately mean that the company can no longer produce anything at all (if the cost of their inputs rise above their sale price cap).

The only way to make a price cap work is to set all prices in the economy, which as you observe, is not possible. The much more practical solution to maintaining a stable general price level is to adequately control the quantity of money that exists.

[jimnotgym]

There is also a government role in making sure an efficient and fair market exists for goods, by working against cartels and monopolies for instance.

The gas price shock is partly caused by a massive supply shock, but also an unwillingness of the cartel to increase supply, since they are doing just fine with the high prices.

I think we are seeing something similar with (for instance) Amazon. A gross simplification is that Amazon has achieved market dominance in many goods. This has reduced competition from smaller businesses, who can't compete in price. However those local stockholders would have been more resilient in the supply chain crisis than the Amazon ecosystem, because they bulk shipped stock to their warehouse (where they held stock), vs drop shipping it on demand from some distant place. This was costlier at the time, but arguably better for the environment and the resilience of the economy.

Right now Amazon is not the cheapest on anything and doesn't have everything in stock for 24 hour delivery any more. It doesn't fulfil its promise of being cheaper or faster. Government could put various controls on Amazon, but instead let us traditional businesses fight to stay alive against it (or be forced to sell through it!). Personally I think Amazon marketplace should be split from Amazon the store for this reason. You can't be the marketplace and a participant.

[rogersnm]

> There is also a government role in making sure an efficient and fair market exists for goods, by working against cartels and monopolies for instance.

> The gas price shock is partly caused by a massive supply shock, but also an unwillingness of the cartel to increase supply, since they are doing just fine with the high prices.

I certainly agree with these points.

> I think we are seeing something similar with (for instance) Amazon. A gross simplification is that Amazon has achieved market dominance in many goods. This has reduced competition from smaller businesses, who can't compete in price. However those local stockholders would have been more resilient in the supply chain crisis than the Amazon ecosystem, because they bulk shipped stock to their warehouse (where they held stock), vs drop shipping it on demand from some distant place. This was costlier at the time, but arguably better for the environment and the resilience of the economy.

Retail shopping remains one of the most competitive sectors in the economy. It is true Amazon has raised the bar for service, choice and price, and benefits from economies of scale, which has made it difficult for other businesses to compete, however we’re very far from Amazon having a monopoly on retail shopping (you can also see this in their very slim margin on their retail business - if they were dominating, they’d have a substantially bigger margin.).

> Right now Amazon is not the cheapest on anything ... It doesn't fulfil its promise of being cheaper or faster.

It is somewhat unfair to say that Amazon is bad because smaller businesses cannot compete on price, and also say that Amazon is expensive and other providers are cheaper - both of these statements cannot be true.

[makomk]

There are some other obvious reasons for that unwillingness to increase supply that I think you're missing. Any substantial increase in supply would require investing money in new infrastructure, since it's currently at close to capacity. For the last few years environmental activists have campaigned against any investment in fossil fuel production with some success and this makes it a lot harder to get funding. Also, you may recall that there were a bunch of articles claiming fossil fuel assets would become stranded and literally worthless due to the global push for net zero, and how fossil fuel companies were basically scamming investors by ignoring this risk. The companies are acutely aware of this risk and have been quite cautious about expanding capacity as a result.

[medvezhenok]

It would cap reported inflation, but capping prices just turns inflation into shortages (since demand > supply either way), and potentially slows down the supply response (high prices incentivize more supply).

If supply is actually restricted (and can't be increased), then capping prices makes sense in certain scenarios, and indeed price caps have been used historically in the U.S., from the 1940s through the 1970s.

[raydiatian]

I haven’t studied Econ too much, but I know differential equations. Is there any economic theory suggesting a stable curve that doesn’t oscillate around the mean (but rather tightens up right onto the “mean” whatever that is) is desirable? I get we’re also talking planet scale complexity, and it’s not like that can just be baked in overnight.

[barry-cotter]

The costs of inflation are mostly in surprise, adjustment, monitoring or uncertainty. A stable rate puts all of those at or near zero. High, stable, predictable inflation would be better than usually low but unstable inflation. For a perfectly fine introduction to why inflation is bad see the link below.

https://quickonomics.com/the-costs-of-inflation/#:~:text=The...

[BizyDev]

Certainly what you point out is probably part of the problem but it is, in my opinion, certainly not the biggest part.

For me, current inflation is caused by the fact that people have too much money the do not need and they invest it instead of buying goods.

This leads too more speculation on everything, stocks, cryptos, energy, real estate and even staple foods.

In the last 10 years every of those indexes has gone massively up. This has resulted in companies having share prices increasing faster than their performance would have suggested. If there's more demand for company X stocks then the price will go up even if company's performance is not so great.

And here starts the loop for me, company X employees want a slice of this cake. Their are recompensed for the higher stock price (bonuses, wage increases) and not for their "real life" performance. And now those employees have even much more money they didn't need, so what they do? They invest and speculate => loop.

While the upper middle class (and above) has became richer thanks to this (more salary, stellar investment performance, low interest rates to invest even more etc) the bottom class has lost everything, they have pretty much the same salary than 10 years ago but everything is more expensive.

Nevertheless, almost everywhere in the world, we have also seen wealth tax cuts. So those who had money to invest have now even more and those who need to be helped are helped even less because less taxes means a state less able to help them.

All of this have brought us to where we are today. Unfortunately.

[galaxyLogic]

You make a great point if I understand it correctly:

Problem is not that people have too much money. Problem is that (some) people have more money than they need.

[rogersnm]

> If inflation is caused by people having too much money then it is a self-correcting problem because as prices go up people will no longer have as much money. Soon enough they will not have too much money at all.

The problem is a situation of run-away inflation can arise. This happens because the vast majority of the money supply is created by commercial banks lending activities (not central bank reserves as many seem to believe) - i.e. whenever any commercial bank lends, it creates new money.

When inflation goes up sharply, real interest rates can become sharply negative (as they are presently), and this provides an incentive to borrow money at negative real rates, where you profit by not having to repay as much in the future as you borrowed in real terms. This borrowing/lending activity itself then serves to further increase the money supply, until such time as interest rates are raised sufficiently so as to bring the (expected) real interest rate back into positive territory, thereby removing the profit incentive that drives marginal money creation.

[nverno]

Why isn't the Fed raising the reserve rate (apparently it was set to 0 in 2020[1]) to reduce commercial banks creating new money?

[1] https://www.investopedia.com/terms/b/bank-reserve.asp#citati...

[rogersnm]

The Fed is doing exactly that: https://fred.stlouisfed.org/series/FEDFUNDS

[nverno]

Ah thankyou, do you think it will spike anything like it did in the 80s?

[edit: I see she discusses this in article as well, now]

[rogersnm]

Predicting the future is always difficult, there are elements of now that are similar to the past, and there are elements that are different. It also helps to have experienced those past events and been able to learn lessons from them.

It seems highly likely that inflation will remain at its current elevated level for at least another 12 months, beyond that horizon, the trajectory will be determined by what happens between now and then.

[imtringued]

That's a better idea than raising interest rates but it has the downside that banks are so fragile nowadays that any raise in the reserve requirement could cause a chain of bankruptcies.

[pcai]

inflation is only initially caused by money supply. once inflation expectations become embedded, it becomes a self-reinforcing perpetual motion machine.

e.g. imagine you negotiate a 13% raise because inflation was 13% last year (btw so did everyone else). congrats - everyone just guaranteed that they will have enough money to create 13% inflation next year, when the cycle will repeat

unemployment solves this because it's a "-100% raise" and takes spending power out of the economy

and inflation is generally considered bad because among other things it distorts markets for savings and loans

[barry-cotter]

> it becomes a self-reinforcing perpetual motion machine.

Only until expectations catch up with the reality of the money supply. If there isn’t enough money in the business’s account to pay that 13% raise people get fired or the contract gets renegotiated, or the business goes under.

[pcai]

once inflation is embedded in the economy the velocity of money matters more than the supply, because the sticky price effect causes a spiral.

there will be enough money in that business's account because they will do the obvious thing and increase prices by 13% - after all, their costs are up and their customers are making more money so they can easily absorb the increase.

here is a simplified illustration of the phenomenon https://archive.nytimes.com/krugman.blogs.nytimes.com/2008/0...

[1vuio0pswjnm7]

"I've been following the discussion on US TV and they say we need more unemployment."

The Federal Reserve Chairman actually said this in a speech several months ago.

Maybe if we sacrifice a lamb, things will get better.

For this unemployment "solution" to work, more people have to be out of work. Sacrificial lambs in 2022.

As things improve, "the rising tide will lift all boats". Except for the sacrificial lambs who will sink like stones.

[Aunche]

Please share a source. I googled this with several different variations of quoting and only saw your HN comment

[AnimalMuppet]

What the Fed actually said is that they need to raise interest rates to get inflation under control, even though that will likely cause greater unemployment. Various people twist this into the Fed saying that unemployment is the goal, instead of a negative side effect.

I don't know why people twist things in this way, but I've seen people repeatedly do so.

[galaxyLogic]

It is easy to understand that way. If people lose their jobs that will reduce demand which will reduce inflation. The goal of Fed is to reduce inflation and one way of getting there is to slow down the economy which causes more unemployment.

But Fed has another goal too which is preventing unemployment. They are in a twist.

[ac29]

What he said was "there will very likely be some softening of labor market conditions", which was interpreted to mean increased unemployment.

source with video: https://twitter.com/CNBC/status/1563172126945067009

[mudrockbestgirl]

> So what is the real problem with inflation? Is it the economic inequality it brings to those who have to live on fixed income?

Yes, that's part of it. Inflation is a race. It's not a problem for whoever gets access to the newly created money first. It's a tax on people who have fixed income (or cash reserves) of some kind, because they will be the last group the new money flows to. It's not about the increase in money supply, which doesn't really matter because the market will adjust prices, it's about how the newly created money flows through the economy.

[nyokodo]

> People will then have even less money after paying the grocery and gas-bills.

Precisely. The less money people have the lower prices have to go for sales to be possible so increased unemployment is a downward force on prices but isn’t all that successful right now when there’s also a massive skilled labor shortage in the vicinity of record expansions of the money supply.

[rightbyte]

Instead of forcing some people into unemployment wouldn't raising taxes a little bit on everyone have the same effect?

[happymellon]

Yes, but the people who raise taxes are not the people who understand economics.

[lkrubner]

Imagine a country that has no international trade of any kind. If this country has inflation, the inflation has to be because of an excess of dollars over what can, in the short term, be supplied. (Over the long-term the stimulus of spending should lead to an increase in supply, which is why every nation prefer inflation to be mildly positive rather than mildly negative.)

But imagine a country that imports 25% of GDP and exports 25% of GDP, so that trade makes up 50% of the GDP. Now it can have an increase in inflation without a change in its monetary policy. For instance, if it buys a critical supply from a country, and that other country has an appreciating currency, then suddenly the imports will be more expensive. This is with no change to domestic monetary policy.

[lordnacho]

The problem is not that prices keep going up, is that they do so unevenly among various goods and services. This adds a dimension of instability that makes it hard to decide what to do for everyone.

[paulpauper]

Higher unemployment is generally deflationary according to mainstream economic theory and empirical evidence

[rogersnm]

Correlation or causation though? If it's correlation then higher unemployment is not in and of itself deflationary, it's just that whatever causes higher unemployment also causes reduced inflation. A non-causal link makes more intuitive sense than a direct causal link: as we go from monetary stimulus (having too much money) to monetary contraction (having too little money), demand for labour cools, as does the rate of increases in the price level.

[c7b]

Think about it: if inflation is caused by a higher growth rate of the money supply than the real output growth rate, as you suggest, then how would higher prices change anything about that? The money that you leave in the shop doesn't leave the system, it just flows to employees, suppliers and owners of the business, ie to other people. It's still very much in the system, the money supply hasn't changed at all.

Inflation is anything but self-correcting, as countless episodes of hyperinflation have demonstrated: a thousand percent a year, ten thousand, ten billion percent - we've seen it all [0]. And that is the real problem with inflation: it truly has no upper bound. And above certain levels, it's very hard to bear.

[0] https://en.wikipedia.org/wiki/Hyperinflation

[rogersnm]

> how would higher prices change anything about that?

Higher prices reflect a new equilibrium between the quantity of money and the quantity of goods and services being produced. Until that revised equilibrium is reached, you generally suffer from shortages of goods and rising prices.

> It's still very much in the system, the money supply hasn't changed at all.

The money supply doesn't need to decrease for inflation to stop, it just needs to stop increasing on an output-adjusted basis (and even then you need to wait for the equilibrium to be roughly reached before price levels stabilise).