What is Inflation Anyway?

I feel like we have made inflation deceptively simple. We have this exact number for it. The Bureau of Statistics will declare something like “last month, the inflation was 2.46%, annually adjusted.” It will do so with an number that is so precise that at will have at least two decimals, implying the surgical accuracy employed to get to that particular number.

We don’t seem to ask ourselves how we come up with these number, do we?

Do We Even Know What Inflation Is?

The great Milton Friedman did not have even a shadow of a doubt: “Inflation is always and everywhere a monetary phenomenon.” Well, here is what the equally great Robert Solow said about Milton Friedman: “Another difference between Milton [Friedman] and myself is that everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of my papers.”

In Japan they have been expanding the money supply for decades. They can’t seem to produce inflation, no matter how hard they try. If we ask the European Central Bank what inflation is, they say something like “inflation occurs when there is a general rise in prices.” (They will also ask if you have seen the inflation monster and offer you to watch a cartoon about price stability).

If inflation is just general rise in prices, then why do prices rise or fall? Most would say, because changes in supply and demand. Don’t prices of products and services tend to drop over time? How do we even measure this?

How to Measure Inflation?

This seams to me an exceptionally tricky undertaking. If inflation is supposed to measure changes in the price of the stuff we buy over a period of time, what happens when we start buying different stuff over time? Our behaviors and preferences are constantly changing? Imagine a lab scientist that has to test his experiment on rats one day and then repeat the experiments with hamsters.

Do you see the problem here? The stuff we buy is not constant. Take mobile phones for example. How can you realistically measure the inflation in mobile phones from one year to another? Or even, how do you compare the price inflation of mobile phones to a period 20 years ago, when there were no mobile phones?

What about all the stuff we don’t pay for yet derive some benefit from? How do you factor in the change in cost of consuming Google searches into any inflation measurement? Should you measure the increase and decrease in paid ads displayed with organic searches? 

And there there are substitute products. If pork rises in value, relative to beef, you might be inclined to consume more beef and less pork. But the baskets of goods and services will take that into account.

So next time, when you see an inflation number with a couple of decimal points. Ask yourself how it was measured and how accurate that measurement could be.

Universal Basic Income and Inflation

Imagine if the government would decide that everybody would receive a monthly check of $4,000 as a Universal Basic Income. Now imagine that you are in need of a good plumber. How much do you think the plumber will charge:

  • Less than before UBI.
  • Same as before UBI.
  • More than before UBI.

If you think that the plumber will charge less than he did before UBI, you are probably overestimating the compassionate nature of plumbers. If you think a plumber would charge the same as before, you are assuming that plumber will disregard the effect of extra monthly $4,000 to their life.

My assumption would be that most plumbers are not plumbers of passion. Rather, they entered into plumbing because it paid well. The reason it pays well is because nobody aspires to be a plumber. But there is a price where the occupation of plumbing attracts enough of people to satisfy the need for plumbing.

My guess would be that many people would of alternative uses of their times when presented with Universal Basic Income. But the jobs aspire to leave behind would still need be done…just at another price.

In Defence of Inflation | Bitcoin

It is not uncommon to hear proponents of cryptocurrencies in general, and Bitcoin in particular, make a libertarian case for the future adoption of the cryptocurrency. The libertarian case would be something in the vein of governments using fiat currencies as a means to illegally tax their citizens by means of money printing. For each dollar that the Federal Reserve prints and brings into circulation, the denominator increases while the total wealth of the economy stays the same.

 There are two arguments to be made against the libertarian case:

  • Inflation is a feature, not a bug: Before fiat currency, most national currencies were pegged with gold or silver. You could basically exchange your Dollars for a fixed amount of gold or silver. The gold anchor caused supply constraints when people were fearful. The currency became harder to come by when people were pessimistic which in turn amplified the deflationary pressures. 
  • Most of the time, you are not long the dollar. When you get your salary transferred into your account at the beginning of the month you consume some of it and you save some of it (hopefully). If you buy a property, you no longer are holding the dollars. The property is only denominated in dollars. If more dollars come into circulation, the property will have the same value but will be worth more dollars. 

What would happen if you knew that the dollars you got paid out at the beginning of the month would deflate by 20% by the end of the month? If you are a reasonable person, you would try to delay any use of your dollars until the end of the month. You would hold back on spending because your purchasing power would increase. Again, the inflation rate of the modern currency is a feature, not a bug, as it stimulates economic activity. 

The deflationary structure of Bitcoin might make it a good store of value, but less so a medium of exchange. 

More Thoughts on Crypto

Want to collect interest on your crypto? Sign up for a BlockFi account with this link and receive a $10 bonus in Bitcoin when you fund your account.