I understand why inflation currently happens. The price of gas goes up, so the cost of transporting goods goes up, so the cost of production goes up, etc etc. I can wrap my head around that. But how did it start? What was the first thing to go up in cost, creating this chain reaction? Could it have been avoided if the initial thing did not rise in cost?
In: Economics
Inflation doesn’t have a starting or ending point. It’s a normal and desirable phenomenon in a growing economy.
I guess if you had to name a starting point, I’d say the abolishment of the gold standard somewhere 20’s. That would still be arbitrary though.
For one, at least some inflation is a policy decision. The government manages the money supply and does so in a way to target modest inflation as deflation is terrible for an economy and modest inflation provides an incentive to spend and invest.
Extremely broadly, inflation comes from one of two sides, demand or supply. “Demand pull inflation” is where people have a greater willingness to spend money on stuff (perhaps due to greater levels of employment or an increase in the money supply). People start bidding up the price on the limited supply of stuff available, pushing up prices. “Supply (or cost) push inflation” is when our ability to make stuff becomes constrained but people still have just as much money.
Both of these factors are, to some degree, at play all the time. For the past few years consider the following (also extremely broad) drivers of inflation. There was a *huge* amount of stimulus governments utilized in the face of Covid. This flooded cash into the economy and, all else equal (which it, of course, was not, but this is eli5) that increases prices. At the same time, due to lockdowns, people’s shifting preferences to goods and then back to services very quickly, supply chain issues, etc., our ability to supply stuff was much more constrained.
In a non- fiat currency? When you introduce the materials. Mining, harvesting, or building shit increases wealth, because people make things from other things, and buying those things increases wealth. Those kinds of financial markets only grow with input. So if someone floods the market with a thing, or a thing is decreased (farming goes fallow or you can’t find any more oil, or shiny rocks, or your people die), your economy adjusts.
In fiat currency? When the controlling body adds more or removes some currency. You can input raw materials, but add currency, and your relative wealth can stay the same. Or remove currency when the material input slows, and keep it (close to) the same. Or reverse either one and try to hit a moving target of 2% growth, but currency manipulation is how you keep the spreadsheet moving.,
Inflation, in a simplified sense, has two causes, either more “money” or less products. In older economies (think Ancient Rome or even middle ages) not many people actually used money in daily transactions so it didn’t affect the economy so much.
If money is tied to gold (think gold coins) you can’t really print money out of thin air, sure, some new gold may be mined but that is slow and laborious and sources of gold are already known about and their productivity is kind of stable, you can’t really make gold out of thin air, can you?
Nonetheless, inflation did happen even when money was tied to gold. When Spain (more like kingdom of Castile) reached the New World they discovered a lot of gold, which they then used to mint new money, and this had the exact result you would have expected, inflation in an age where people didn’t really knew about it or how it works.
For the other example where the quantity of money stays constant but products are less I can’t really think of an example, but for example, when the Roman Empire fell (it wasn’t a singular event but more like a long process punctuated with major events, but that’s another discussion) people stopped using money less and less, basically making it become less valuable. Without the economic transactions that the stability of the empire brought coins where less important than being friends with you neighbours in the village or being able to bring together several armed men.
For a more theoretical example, we can have inflation even without money. If caveman Grogg sells a fox pelt to three other cavemen for a fish each, but tomorrow Grogg only catches one fox and one of the buyers offers two fishes to guarantee he gets the pelt, then now we have all the required components for inflation, don’t we’ll?
Short version; inflation and deflation exist whenever money exists. It may have different causes or different manifestations and in some way doesn’t even require money, just transactions.
In your analogy, it started when gas price went up. Which was a decision of the supplier.
>But how did it start? What was the first thing to go up in cost, creating this chain reaction? Could it have been avoided if the initial thing did not rise in cost?
You’d need to go back in time before money existed to know this.
But ultimately, it is about supply and demand. If demand for a good randomly goes up faster than supplies available then the supplier will be incentivised, or else pressurised, to satisfy that extra demand.
But they won’t have enough goods – and need money in order to produce extra stock. But then they can’t increase output in order to get extra money, because it’s that same extra output that they can’t afford to produce.
So how can suppliers acquire the extra money through their existing stock?
They’ll inflate the prices so that they get extra revenue per item, so that they’ll have extra money to reinvest back into producing more goods.
And so “how did it start”? Usually via either an acceleration of demand of decrease in supply.
One tricky thing to understand is that inflation isn’t one thing, there’s lots of types of inflation. They have different causes and different results.
The Spanish Empire used primarily silver coins, but also gold coins as their currency. They mined incredible amounts of gold and silver from their colonial territories, brought it to Spain, and experienced huge amounts of inflation because they had so much gold and silver.
The interwar German and 80s-90s Zimbabwe governments had paper currency, and printed incredible amounts of money to sustain government spending/paying foreign loans. This caused hyperinflation as the past money was essentially valueless
There’s also something known as Baumol cost disease- which is present in many modern economies. The idea is that as economies become more productive, wages in a variety of industries go up, which leads to some inflation. Basically, if everyone is a sustenance farmer, wages are really cheap, so it’s cheap to hire a servant, or really anything, because the alternative is poverty. So an average teacher in a high wage country like the US makes a far higher salary than an exceptional teacher in Mongolia (because a US teacher has other high income options). This is balanced out to some extent- more productive economies produce more goods and services- but it does mean wages go up over time.
Next- there’s inflation that can come from government spending. For example, if the government decides to build a ton of roads, then they may hire a ton of engineers. This can make building high rise apartments more expensive- because they also require engineers, and construction companies are competing with the government for hiring.
There’s also some temporary inflation you can see from disasters/other events- like bad harvests or natural disasters, or supply disruptions. In a hurricane, everyone wants to buy food, so you see price gouging and shortages. When bad weather causes a poor orange crop harvest, orange prices go up. When there’s an auto manufacturing strike- there’s less cars made, so car prices go up.
Finally, there’s inflation targets. Rich developed countries like the US have central banks manage inflation, and often have low, but steady inflation targets. The aim is to keep average inflation low, but above zero. From the above- you can see that some segments of the economy (particularly labor intensive ones) always will have some inflation in a growing economy, so targeting zero inflation would mean allowing inflation in some areas, and forcing deflation in other areas, and deflation is very bad. There’s also some trade off between unemployment and inflation at times. People don’t generally take nominal wage cuts, so if the economy is struggling and inflation is zero, lots of people might get fired. On the other hand, if inflation is high, and wages stay flat, then employees are taking an effective wage cut. This is not popular, but it’s usually easier to accept than salary actually decreasing, and it’s often preferable to a nation than high unemployment.
The pandemic disrupted Manufacturing and global supply chains. The invasion of Ukraine compounded matters by disrupting the energy sector. Floods, drought, and wildfires have decimated crops, sending food prices soaring. It’s no one thing. Expecting it all to be fixed in just a couple years is unreasonable and naïve
Inflation is generally a catch all term but it doesn’t just mean prices go up for something. It means that the cost of something goes up across the entire demand curve and usually across multiple things. Prices can rise without inflation if there’s a change in supply or demand. When supply and demand return to normal then so do prices. If prices don’t return to normal then that would be inflation (or possibly deflation)
Inflation is an ongoing thing that probably predates written history. If we trade goods back and forth but I develop a new technique allowing me to yield more corn. I now have more corn to trade. I can buy more stuff (I have more money). Sellers react to this in one of two ways. Raising prices or producing more. If they can’t produce more then prices go up to meet the the shift in demand.
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