How does inflation work?
In: Economics
On a very basic level, the more money is circulating the less resources the same amount of money buys you. Just imagine an island with 100 people on it. If there is 10 dollars on the whole island, someone might give you a house for 1 dollar (=one tenth of the whole amount of money on the island). If there is 1,000,000 dollars circulating.. 1 dollar probably won’t get you a coconut for exchange.
However, in real economics this leaves the question, why there is getting more money. In our economy, money isn’t directly “printed” by the state. Something many people don’t realize, if you loan money from a bank, the bank has the right to “create” that money. Many think they give you the savings of other people, but that’s not the case. They just put a number on your account and you’ll have to pay it back in the years to come.
There are many subtle ways the state can influence on how much money people are creating by loaning (most important the cardinal rate but there are others as well). One reason why economic regulation wants to keep some sort of inflation is to have a safety clearance to deflation. Once an economy hits deflation (money get more worth over time) it’s getting devastating for everyone. Because people will take out the money of any investments just holding the cash and industry / projects and so all stop.
Another reason inflation happens naturally is the incentive of everyone increasing prices. Shopkeeper every once in a while will increase prices when they think they can get away with it. Workers will demand pay raises. And people taking loans for building a house will have to loan more to pay for increased material and work thus creating more money. And this makes the rat race complete as the value levels down again. The economy only really grows by technical progress, not by pushing prices.
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