It is a bit like Alice in Wonderland: governments want some inflation; not too much but not too little. When there is inflation, debts shrink in real magnitude, and governments are notoriously deeply into debt. So, the more the better? Well, not quite. The classic example was Germany during the 1920s, where as soon as you got money, you spent it, or even better, converted it into something else that was not inflating. The German economy effectively collapsed, apart from isolated examples, such as the chemical industry. The reason they survived was because they exported much of their production to the US, and received their income in US dollars. They then paid their workers in something such as “aniline money”, which was convertible to US dollars, and their workers generally made purchases at company stores that sold in “aniline money”. So, in any economic problem, there are always some who survive, usually through being big enough.
There is the other side of the coin. While debtors see their debts inflate away, which in my opinion is essentially basic dishonesty, few want to lend, and if inflation gets high enough, nobody has anything liquid to lend. If you have money, it is converted into something else as quickly as possible. Workers don’t work very hard because the employer is not paying them. The instant they are paid, they are off to turn this paper into something else. So while governments want inflation to get their debts inflated away, and they will wave away the dishonesty aspect by arguing it is the people as a whole who benefit, they do not want it to be so big that people refuse to lend.
So why have inflation at all? One reason stated is that if there is next to zero inflation, the next downturn will lead to deflation, and during deflation people try not to spend, which exacerbates the problem. If people stop buying, there is no point in making the same amount of stuff. Companies either fire staff or go under, which leads to more unemployment and so many more people who cannot service their previous debt. This leads to a higher risk of bank failure. The risks of debt to equity ratios get worse, so more firms will go under, and that puts a lot more pressure on the banks. Another reason is that sustained low inflation means that there is little scope to cushion the next downturn, i.e. the banks have no tools left. As turnover drops, tax returns decrease in value but debt levels stay high, and accordingly the governments have less room to move. As you may notice in these situations, the whole reasoning for whatever is being decided is to make life easier for the banks, or for the government. The whole financial management system is designed to require the least effort from financial managers!
There is a problem here that can be left for a later post, but basically it lies in the possibility that the economies of the world are changing, the rules are changing, and we cannot use the past to predict what is likely to happen in the near future.
Which leaves the question, is zero inflation a disaster? In this context, after Isaac Newton left the British Mint, the value of the pound remained constant more or less until the first world war. During that time, Britain became an economic superpower. Since then, the value of the pound has tanked, and Britain is not. True, there is more involved in Britain’s decline, but the prolonged time during which there was effectively zero inflation did not do Britain any harm. (Note that some prices would, of course, rise. Property prices in certain parts of London rose because there was a shortage of land, but that does not count in the inflation concept.) Further, during that period there was significant investment that powered the Industrial Revolution. Of course it also contained horrible wealth inequality, but that was endemic, and was essentially a consequence of feudalism. There were also serious downturns, but there is no evidence whatsoever that that had anything to do with the value of money, and as yet I do not believe we have an answer to the question of economic cycles and their downturns. So my conclusion is, there is no reason whatsoever to argue that we need inflation, other than to make life for governments and bankers easier. That, in my view, is not an acceptable reason as it has little or no public value.
All of which leaves a problem for writers such as me who write futuristic novels. It seems to me that the world economic situation is changing, but it is far from clear what to? That it is changing is something I shall write about in a future post, but right now, if anyone has any comments along the “what to?” lines, I would love to hear them. In my ‘Bot War novel, the change is forced on the government because economic growth has become negative, and debt servicing takes up too much of the income. Accordingly, the government is forced to reduce current services, and this is not what is required when a crisis appears. But there have to be other possibilities. Your opinion?
Economics is a mystery to me, so unfortunately I have no opinion, except that the world is probably in for more shocks like the “dot-com bubble” and the 2008 crisis.
Economics seems to be a mystery to everyone, and in part because nobody knows how people as a whole are going to respond to whatever happens. I am reasonably sure there will be more crises, though.
Economy is whatever the government wants it to be. I am not sure the value of the pound did not change for centuries. Closer by, the “30 glorious years” had persistent inflation. I have reasons to love inflation.
In any case, there few weapons against deflation, short of a massive command economy.
4% inflation best:
This obviously needs more discussion than this simple reply permits. First, the value of the pound was , of course, relative to something else. Various prices went up and down, but the pound was, from memory, a pound weight of silver. The problems with inflation, in my opinion, is (a) oddly enough, the rich really benefit because they have the means to borrow more, and see their obligations inflate away, and (b) it kills new ventures for those trying to get out of the base, because the interest charged gets out of hand because new ventures seldom make money in he first few years. My concern is to get the enterprising off the bottom rung.
And I have a technico-ecoomical reason for inflation…
I await a view of it.
It’s in my essays above