One of the most popular posts on my blog has been the Idiot’s Guide to Inflation. Recently, however, I received the following feedback on that post:

How is this a fucking idiot’s guide? This is still too complex.

My aim when I wrote it was to explain it as simply as possible. But what seems like a simple topic, really isn’t simple, and perhaps my first attempt wasn’t as to the point as it could have been. So I am taking another try at it and hopefully it will easier to understand.

To start off the remix, I want to point out that some component of inflation is naturally occurring, and exists even in a barter economy. Suppose a simple economy where there are two groups of people, orange growers and apple growers, and they trade apples and oranges, generally one for one.  One year the orange crop experiences a bout of hungry insects that eat many of the oranges, but the apple farmers are counting on their oranges, and they bid up the remaining orange stock so that the exchange is two apples to an orange. Viola, orange inflation with no money involved.

This is a simple example that illustrates the impact of supply and demand on prices. The way I’ve explained it here may seem foreign, but one does not need to go to a hypothetical economy where all trade consists of apples and oranges to experience this type of inflation. In my view, it is the most common cause of inflation that most people notice even while trading dollars for all kinds of goods, especially food and gasoline.

The inflation topic gets more complex with money involved because while there is always some degree of natural demand in the economy, in some sense, it becomes a nominal function with fiat currency, and the degree to which inflation is impacted by increases in the supply of money depends somewhat on the condition of the supply side and whether there are means for it to efficiently expand.

Regardless of the propaganda floating around on the internet, printing up a whole bunch of money as in quantitative easing is not a sure fire recipe for 1970’s inflation unless we have Hugo Chavez in the White House, in Congress, and in Governor’s Mansions all across the country. Lots of money printed on top of bad supply side policy as far as the eye can see is the recipe for outsized inflationary pressure.

If you’ve listened to too much “punch bowl” propaganda that tosses about the illusion of investors gorging on free cash piles with reckless abandon as a result of printing money, just ask average Venezuelans how gorgey they feel right now – and that is the problem in Venezuela. There are mac truckloads of money floating around there, but nobody is in the mood to take the risk to expand the supply side, like building a new factory or engaging in a start up, likely due to the corrupt kleptocracy ruling the roost. So they have all this demand stoking that is likely coupled with a shrinking supply side.

 

That’s it for today. Stay tuned for part two – inflation targeting.

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