Wednesday, October 26, 2011

Inflation monster or inflation fairy??

I wanted to touch on another point made a few weeks ago at the financial fireside described here. While reiterating the fact that we consumers can only spend post-tax dollars (while having to earn pretax dollars), the speaker took a moment to explain the pernicious effects of inflation. It was the typical diatribe, which described the way it eats away at our purchasing power. This is true of course, but the narrow description lacks a acknowledgement of the state of consumers’ balance sheets and the corresponding effect on the economy overall.

One of the first things to think about when discussing the flagging economy or the current state of the average American’s finances is the fact that most people are saddled with a pile of debt. The servicing of this debt is one of the main obstacles to increased consumer spending (along with flagging incomes, and depressed stock and house prices). As our debts are set in nominal dollars (i.e., without regard to inflation), while our incomes generally rise with inflation, a moderate rise in the price of goods across the board would, overall, leave the consumer with less debt. This is a good thing.

Since, with inflation, this debt relief would be occurring across the economy, people would suddenly have more money to spend on other things and some of the binge-y overhang from the last crisis would be eliminated. People with piles of cash would also be more likely to spend, instead of simply watching the value of their money erode. This would all help stimulate the economy at a time when there are greater than 25m people currently un- or underemployed. Don’t get me wrong, inflation is a net transfer of wealth from creditors to debtors. But, considering the resultant effect on the economy, and the broad-based benefits that would subsequently accrue, a burst of inflation would currently do more harm than good. Whenever you hear a speaker or politician railing against inflation (with our economy in its currently depressed state), it’s because they’re a creditor (or a rentier even). It’s not because they’re looking after your interests.

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