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November 26, 2007 Inflation = Static in Price Signals |
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This post was a response to a student's post
about inflation.
Great thoughts. Inflation does tend to redistribute wealth, so that some people benefit at the expense of others. For example, in the 70s, it was thought that union workers were able to use their collective bargaining power to keep ahead of inflation, while many other workers and the elderly ended up worse off. That said, I do not think inflation is simply a zero sum game. Remember that the price system send signals to the economy that ultimately results in the allocation of resources to their highest uses. In other words, the economy shifts resources to produce what people most want. Resources flow from producing buggy whips and to producing laptops. Inflation adds static to price signals. People cannot tell is a price is moving because of increased demand or simply as a result of inflation. The higher the inflation rate, the more static that is added to the signal. In a hyper-inflation, all you have is static and the signal does not get through. If inflation is causing prices to increase at 100% per week, the miniscule amount of price increase due to increased demand would no longer be detectable. Money is dropping in value so fast that people are driven to convert money into whatever else they can buy as fast as the can, even if their only reason for the purchase is to try to use the item for barter later on. Since a stable price system sends a clear signal and causes resources to be allocated efficiently, a free market can produce a very efficient economy. As inflation increases, price signals become blurred, and the economy becomes less and less efficient. In other word, inflation does not simply mean that some win, some lose, but on average there is no change. It really means that on average we are actually worse off. Less is produces and more resources are wasted.
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