Interpreting Inflation Incorrectly, Imprecisely, Incoherently

RSS NEWS AAN Headlines, TEXAS

This Post was originally published here: Source Link

CNBC recently published an article whose original title demonstrated a fundamental misunderstanding about inflation. The wording was so misinformed that it prompted intense criticism and CNBC changed the article’s title.

It originally read “The upside to inflation: rising wages” and was changed to “It’s not certain rising wages will be enough to outpace inflation.” Ironically, after posting a critique of the CNBC headline, Fox Business posted its own article with an equally misinformed headline: “Inflation inflicting near-term pain, but promises long-term gain for seniors.”

These headlines misconstrue the fundamental mechanism that causes inflation.

As Milton Friedman frequently said, inflation is always and everywhere a monetary phenomenon. Inflation occurs when the amount of money in an economy grows faster than the growth of goods and services in that economy. The ultimate power to create fiat money lies with America’s central bank—the Federal Reserve (the Fed).

The Fed is aided by two other entities: Congress and the Treasury.

Congress is spending money at a breakneck pace, and the Treasury must write those checks. When there is not enough money from tax receipts, the Treasury borrows the rest by selling bonds at an auction. When the public buys those bonds, the money is merely changing hands. But when the Fed buys those bonds, the money comes from somewhere else—nowhere.

Put simply, the Fed has the authority to create money out of nothing for the purpose of buying government debt.

When new money is created, it diminishes the value of the existing money because there is now more of it. The Fed has purchased so many bonds in recent months that it has doubled its total debt holdings. The result is much more money in the economy.

When additional money is trying to purchase the same amount of goods and services, prices rise.

Whether most people realize it or not, every segment of the economy fundamentally functions like an auction house and prices are constantly being bid up or down. If everyone shouting out their bids has more money to spend, then bids naturally go higher.

People often interpret the initial effects of inflation as being beneficial. Consumers have more money to spend, and producers have higher sales. But as consumers compete over limited goods and services and as producers compete over limited inputs, the bidding wars begin. All in all, prices rise, and no one is better off.

But there is one more thing to consider: inflation is fundamentally a tax.

It is a transfer of wealth from anyone on a fixed income, or any creditor, or anyone with a dollar in their pocket or a savings account, to the government. That brings the conversation back to the recent news articles. It is simply incorrect to say that employees benefit from inflation through higher wages.

That is like saying a person benefits from an accident which totals his or her vehicle because the insurance company pays the claim. The person still must go through the hassles of finding a new vehicle, dealing with any long-term injuries from the accident, and paying the deductible. The person is not better off after the accident—the insurance coverage can only diminish the harm. Similarly, higher wages can only lessen the real cost of inflation, but employees are still worse off compared to before the inflationary wave.

Likewise, people on Social Security and other programs with cost-of-living adjustments (COLAs) are not better off because of inflation, neither in the short term or the long term.

In the short term, those people are stuck paying today’s higher prices out of an income that was determined using last year’s lower prices. Even after their incomes have risen, they still cannot purchase more goods and services than before the inflation. Worse yet, the real value of their savings has diminished, being subtly taxed away.

The headlines espousing the virtues of inflation are plain wrong. A more accurate headline would be: “A Tax by Any Other Name: How Inflation is Robbing You Blind.”