Why if I have $100 right now, 10 years later that same $100 will have less purchasing power? Why can’t our money retain its value over time, I’ve earned it but why does the value of my time and effort go down over time?
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ELI5 disclaimer!
Because the number of dollars out there does not perfectly match the GDP at all times.
As the economy increases, if the number of dollars did not increase the dollars would actually start to be worth more. This is deflation, which we have learned is actually really bad for the economy, because if your money is worth more tomorrow or next year, you are much less likely to spend it today. Keep repeating that forever and you have a problem.
So this is why the government has policies in place to keep the dollar growth slightly (but not too much) inflationary. So that you are not penalized for spending your money. Which is what they want, as they get to tax money as it changes hands.
As for your grandparents savings, had they put it into an investment, that had a nominal interest rate, then the value would have stayed relatively the same (or maybe even better) as the years went on. I am sorry they didn’t know to do this. Bank accounts are terrible places to store money long term.
Here’s the thing, the value of money is driven by supply and demand (as with virtually everything else). The Fed could target a supply of money that meets the demand, and over the long run it would have zero inflation. The problem is that monetary policy (i.e. the Fed’s tools) work with “long and variable lags”. This means that a single change in interest rates won’t fully impact the money supply for months, maybe even a year or more. It’s like trying to parallel park an 18 wheeler but not knowing how long the trailer is.
The way central banks compensate for this is to target an inflation rate slightly above 0% so that if they overshoot, inflation does not go negative. Negative inflation tends to create a downward spiral in the economy as people slow down their spending causing inflation to go even more negative. The judgement of policy makers is that a scenario of 2% inflation with low risk of deflation is better than 0% inflation with high risk of deflation.
Inflation discourages hoarding money.
If I just sit on a pile of cash in my checking account, I’m actually *losing* value because of inflation. To prevent this, I need to have my money invested in something. This encourages investment, which (should) spur business and the economy more generally.
EDIT: to be more specific I mean cash. Inflation prevents hoarding of cash, specifically.
Because it really does, in most cases, go down over time.
On a fairly short time period, it is reasonable to expect that a currency retains most of its value and represents a stable store of value and acts as a means of exchange.
But, there is every reason to expect that an hour worked today would be worth less than an hour worked in the future. An extreme illustration would be say comparing the output of a farmer 100 years ago with a farmer today. If a modern farmer achieves the same output for the given input of labor as his counterpart did 100 years ago, that would be a VERY unproductive and inefficient farmer.
There are competing forces at work here. The hour someone worked some time ago would be expected to earn much less purchasing power because that hour in the past is, in a sense, compared to an hour worked today. One other way to look at this is with increasing productivity, one could also claim that an hour worked today should produce more purchasing power since there is (generally) higher productivity.
Looking at a long enough period, productivity (through use of better knowhow, technology etc) determines the purchasing power. An economy that grows productivity at a rate broadly greater than inflation will generally result in a situation where purchasing power grows. Inflation can therefore be seen as an inducement to invest and grow productivity.
The mathematician John Nash actually wrote a treatise advocating exactly this. His arguments boil down to inflation being unneccassary and ultimately a tool for state authorities to inadvertantly tax the populace. He proposed creating a type industrial goods index to peg the value of a currency to.
https://www.jstor.org/stable/1061553
Inflation means prices would increase tomorrow, so it’s better to buy today.
Deflation means prices would be cheaper tomorrow, so people would buy tomorrow. But if the price keeps decreasing everyday, then people would just keep waiting till it becomes pennies.
So having inflation forces you to spend in the now rather than later.
Spending is what makes the economy. If no one spends, there’s no economy. With no economy, there’s no government, no public services (like your roads, street lights, police, fire fighters, etc.)
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And prices can’t stay the same, it’s either 0.001% inflation or deflation, it’s never 0.000%. part of the reason prices change is because of growing population and businesses. If there’s 100 people and there’s only $100 circulating the world, each person only has access to $1, but with growing population, the circulating currency has to increase too or else you’d have less than $1 – which basically means new money is being fabricated/printed “out of thin air”
> why does the value of my time and effort go down over time?
The value of your time and effort (salary) for most people goes *up* over time, thanks to raises. It’s the value of $100 hidden under your mattress that goes down, so you should spend it or invest it instead.
Steady, predictable inflation is good for society, because it makes people who have money put it to work by investing in things.
If you have $100 sitting under your mattress, it will slowly lose value due to inflation. But if you instead put it in a bank, that bank will lend out some of your dollars to somebody else to build a house or start a company, and you get paid some of the interest from that loan. Society gets richer because your money was building a house instead of just sitting under your bed.
And it turns out that deflation is really bad for society. Imagine this: if you knew prices would fall 20% every year, would you buy a refrigerator today? No, you’d wait until later when prices were lower. And if everyone does that, the whole economy grinds to a halt.
It’s really hard to hit exactly 0% inflation, and going negative is really bad, so we try to get a little bit of inflation instead.
**Real inflation example with TVs**
**1983:**
* 50″ projection color TV cost [$1,695](http://www.wishbookweb.com/FB/1983_Sears_Wishbook/files/assets/basic-html/page-400.html#)
* Median US household income: $57/day
* Days to afford this TV: 30 days’ salary
**2021:**
* 50″ HD TV: [$250](https://www.pcmag.com/reviews/vizio-d40f-j09)
* Median US household income: $194/day
* Days to afford this TV: 2 days’ salary
So the median household can buy a 50″ TV with just over one day’s income today, vs. a whole month’s income 40 years ago.
**Real inflation example with eggs**
**1983:**
* A dozen eggs cost $0.89
* Median US household income: $57/day
* Daily income in # eggs: 64 cartons / day
**2021:**
* A dozen eggs cost $1.67
* Median US household income: $194/day
* Daily income in # eggs: 116 cartons / day
So the median household can afford almost 2x as many eggs as they could 40 years ago, ignoring other expenses.
[https://www.usinflationcalculator.com/inflation/egg-prices-adjusted-for-inflation/](https://www.usinflationcalculator.com/inflation/egg-prices-adjusted-for-inflation/)
[https://fred.stlouisfed.org/series/MEHOINUSA646N](https://fred.stlouisfed.org/series/MEHOINUSA646N)
Deliberate government policy:
>Inflation is the one form of taxation that can be imposed without legislation.
–Milton Friedman
>By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
–John Maynard Keynes
These aren’t just any random guys, they are the two most influential economists responsible for the structure of the dominant neoliberal economic regime. And they’re telling you, straight up, that inflation is a de-facto tax. And it is.
Now to be fair, one can construct a cogent argument why a moderate amount of inflation is good. The most popular one is that by making the value of money decline over time, one is encouraged to invest it in speculative endeavors, so as to protect your hard-earned cash from the bite of inflation. But this pre-supposes that people simply wouldn’t do that if the rate of inflation was zero percent. Nothing could be further from the truth. People have been starting businesses, borrowing and lending money, and otherwise looking for ways to turn a dollar into two dollars, for millennia before fiat currency was ever conceived.
I prefer a different justification, and one which I think will probably put you at peace with the phenomenon of inflation, if not in love with it: in practice, a gold standard is really a *price control* on the metal. The same goes for a silver standard, or whatever other material you want to back your ‘inflation-proof’ currency with. But what happens if someone discovers a new and abundant source of gold? Or if there is a new economic application of the metal which increases demand on it? Suddenly you’re in a situation where other market factors are manipulating your currency, and therefore causing prices to inflate or collapse.
Fine, you may answer, gold standards suck, why not keep using fiat dollars, and merely make the inflation target zero? Well, right now the inflation target is two percent, and we’ve had a couple years of inflation more than double that figure, so what makes you think they’re going to be any more successful keeping a zero inflation target instead of a two percent target? Therefore, I think the real virtue of the two percent target is that it helps central banks respond to periods of *deflation* (which is arguably worse than inflation, have a look back at 2008 for an example of why) through the means of manipulating interest rates. In fact, the previous Fed regime where interest rates had already been low for a decade arguably made the 2008 finanical crisis last far longer, because central banks couldn’t stimulate spending by dropping interest rates, because the rate was already *at zero*.
Managing inflation is actually really hard. Most countries do their best to keep it at 2% year over year, but when the shit hits the fan there’s no real be-all end-all solution to it.
Inflation has been a problem ever since humanity’s had an economy. The romans had inflation but didn’t really know what was going on. They thought it was simple: outlaw rising prices, create larger denominations (instead of 5 “dollar coins” create 10 “dollar” coins.) but these practices don’t help. They hinder, actually. If you outlaw rising prices, then the seller stops making a profit, if the seller stops making a profit, they shop closes, losing jobs, shrinking the economy. Making bigger denominations just helps to create hyperinflation. Hyperinflation *sucks*. The prices for things will change daily, until that amphore of wine that cost 20 “dollars” 5 months ago now costs 100.
This is something that happened/is happening in south america starting in the 1960s. A combination of dodgy govermental policies and human psychology perpetuated a cycle of hyperinflation. The government was printing money hand over fist to pay its debts, leading to hyperinflation. And it lasted for so long that people started to incorporate it in their daily lives, ironically creating more hyperinflation. If your whole life the price of milk changed every 12 hours, you keep changing the price every 12 hours, even if there’s no actual underlying reason to do that.
It’s better to try to keep a little inflation since it encourages investment back into the economy. If your 1000$ becomes 9980$ the next year, you’re more inclined to try to make it grow by either using investment portfolios, or other investment opportunities, which helps to create other jobs, which grows the economy.
Regarding the “why” inflation happens… that is a big question. There are a *multitude* of factors, and if someone tells you that they know exactly why inflation happens, you’re either dealing with a liar or an idiot. The big main reasons is that humans will always be human. If a good lumberjack wants a raise, the price of wood increases, if the price of wood increases, the price of timber increases. If the price of timber increases… and so on and so forth. Inflation is so hard to predict and control because it comes from such granular sources so many steps under “the price of bread is 8% higher than it was last year” that it’s impossible to track down.
Always having some level of inflation is considered good for capitalist markets because it ensures banks have a natural rate of interest to lend against.
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