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    Inflation Nation: What’s So Bad About Inflation?

    By Thomas Hogan, Ph.D.

    Good afternoon and welcome to the third issue of Inflation Nation.

    We’re all witnessing inflation firsthand. A gallon of milk used to cost $3.21. The price recently soared to $4.41. Chicken went from $1.88 a pound to $2.13 a pound in a year — that’s a 13.7% increase. New estimates by NerdWallet show that the average American family will have to spend $11,500 more this year to live like they did in 2020.

    From a consumer standpoint — as I’m sure you know — the cost of inflation is clear.

    But there’s more to the story.

    First things first, the premises. One reader, Shaun, wrote in to me last week with this question: “It would be helpful if you could go into the idea some people have that a little inflation is good and necessary for growth. I know Henry Hazlitt in Economics in One Lesson, for example, goes into that a little bit, but would appreciate your insight.”

    Shaun hits the nail on the head here. One of the biggest reasons for runaway inflation is the false premise that it’s actually good for the economy.

    “Inflation, indeed, is throws a veil of illusion over every economic process. It confuses and deceives almost everyone, including even those who suffer by it.”
    – Henry Hazlitt
    Hazlitt was right. Inflation obscures the economic process — and it’s definitely not necessary for growth.

    On the classical gold standard, for example, the average rate of inflation was around zero or even slightly negative, yet economic growth was higher than it has ever been under the Fed.

    Despite (or perhaps because of) the lack of inflation, real GDP growth under the gold standard, from 1790-1913, averaged 4.2% compared to 3.3% from 1914 through 2019. Since leaving the Bretton Woods international gold standard in 1971, things have been even worse. Inflation has averaged 4.0%, while GDP growth averaged just 2.8%.

    Figure from How Good was the Gold Standard?

    So, aside from taking a big chunk out of your paycheck, inflation can also have the negative side effect of slowing GDP growth. That’s no small matter.

    A dynamic and growing economy means more jobs, more opportunities, and higher standards of living. However, inflation creates costs that hinder productivity, slow economic growth, and prevent Americans from reaching their full potential.

    Here are a few more hidden costs of inflation the Fed doesn’t want you to know about:

    1) 🔍 Higher Search Costs | This is when you have to spend more time looking for something. Like if you drive around looking for the best gas prices or go across town because there’s one store that hasn’t raised the price of TVs.

    2) 🍴 Higher Menu Costs | Businesses pay a price for adjusting their prices. Restaurants have to print new menus. Companies might print new signs or change their advertising. Contracts have to be renegotiated. We call these added costs “menu costs.”

    3) 📅 Higher Planning Costs | Planning costs increase during inflation because business managers end up spending more time trying to minimize the negative effects of rising costs. Parents spend more time worrying about their household budgets and less time with their families.

    4) 🏭 Lower Productivity | The instability of the price level during inflationary periods creates uncertainty about the future, so businesses are less likely to hire more workers or invest in long-term projects. Lower investment in factories, equipment, research and technology reduces the rates of productivity and economic growth.

    5) 🪵 Misallocated Resources | Inflation can mislead businesses to overinvest or to invest in the wrong types of products, leading to wasted resources. My colleague Peter C. Earle said it this way on a recent episode of our podcast Liberty Curious (below), “When monetary expansion causes price inflation…the information content of prices is reduced…It’s much more difficult for entrepreneurs to figure out what the best use of resources is and in turn, it’s very difficult to determine whether a given profit is going to be profitable or not.”

    For a look at what happens when inflation becomes a chronic problem, take a look at this moment from history, courtesy of AIER founder Edward C. Harwood.

    “By the late 1920’s the chronic inflating of credit, with its resultant over-issuance of dollars, had spread overseas as a natural result of international trade. The U.S. balance-of-payments account was way out of kilter. Trading partners began to doubt the capacity of American banks to cover the imbalance. They started demanding gold, as was their due, and moved it out of the U.S. in shiploads. The U.S. central bankers, still claiming to abide by the gold standard, tried to rein in inflating by tightening monetary policy. Some say they did so too abruptly and too late.

    The result was that in 1929 over-expanded credit finally collapsed all over the country, just as Harwood had predicted. Most people are familiar with the story: Florida real estate markets went bust; the New York stock market crashed; overleveraged Western farming communities imploded; people in the South couldn’t eat while people in the North couldn’t sell their crops. These were all signs of the misallocation of capital, which, according to Harwood, is a normal side effect of inflating.”

    – From E. C. Harwood: A Biographical Sketch of the Founder of the American Institute for Economic Education

    Well, if you weren’t already worried about runaway inflation before, you are now. Join me next week to kick off the conversation about how to get out of this situation.

    Until next week,

    Thomas Hogan, Ph.D.

    Senior Research Faculty

    AIER

    SOURCE


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