Deflation is seen by economists as a threat to economic growth as falling prices undermine aggregate demand as consumers hold off purchases in anticipation of lower prices. However, deflation is simply the mechanism by which equilibrium is restored amid the reduced availability of money or increased availability of goods due to economic growth. Depending on…
There is a widespread lack of understanding among economists and investors regarding what actually drives changes in inflation rates over the short and long term. In this article, we hope to provide clarity on the subject, explaining a number of important concepts. In particular, the importance of money demand and how it helps explain the…
Intro: While the explanation of ‘too much money chasing too few goods’ partly explains what drives inflation, it ignores other key factors, most important of which are government debt growth and the demand for money. More accurately, inflation is driven an excess of money or government bonds relative to real goods and services production, and…
Intro: In the short term the demand for money tends to be the major driver of inflation. In the case of developed markets, improvements in economic confidence as shown by rising stock prices tends to correlate with higher inflation as the demand to hoard cash declines. In contrast, in emerging markets improvements in economic confidence…
Intro: Inflation can be thought of as the result of too much money chasing too few goods. Increases in the money supply gradually erode the purchasing power of money, but not in a linear fashion. The bulk of global money supply is created by the private banking system, although government bond issuance also has a…
Intro: When more people are working there are more of goods and services being produced, which in the absence of increased money supply tends to lead to falling prices. Rapid growth can occur alongside high inflation but this tends to be the result of increased economic confidence leading to faster bank lending and borrowing, increasing…
Intro: The link between inflation, the money supply, and real GDP growth is complicated by changes in the demand for people to hoard money, something which has become loosely known as velocity. Increases in the money supply may not necessarily be inflationary if people are willing to hold onto the money as a store of…
Intro: From an individual perspective, saving and hoarding can appear to be the same thing, but for the economy as a whole they are very different. Hoarding is the increase in willingness to hold money as a store of value. Saving is a measure of real resources in the economy that are used in the…
Intro: Loose fiscal policy tends to be a major cause of inflation as it increases government spending without increasing real output or reducing the spending of the private sector. Even if governments issue bonds rather than printing money directly to pay for the deficits, the inflationary impact remains largely the same. When the government spends…
Intro: Economists fear deflation for reasons that go completely against the basics of economics. Prices fall during times of falling money supply growth, high real GDP growth, or increased hoarding. In any case, the decline in prices is the market’s way of increasing the purchasing power of money to ensure that output itself doesn’t decline. …
Intro: Concepts such as cost-push, demand-pull, second round effects, and wage-price spirals reflect proximate causes of inflation, rather than ultimate causes. In reality, inflation is the byproduct of the interaction between the production of real goods and services, the money available to purchase them, and the willingness of people to spend this money rather than…
Intro: Lower interest rates tend to create upward pressure on inflation as they encourage greater bank lending, increase the incentive to spend money rather than hoard it, and discourage people from holding the currency as an investment. That said, given the multitude of forces at play, rate cuts are far from guaranteed to generate high…
Intro: Does currency weakness cause inflation or does inflation cause currency weakness? While it may appear that currency weakness causes inflation, the opposite is true. Declining export competitiveness and falling real interest rates resulting from higher inflation necessitate currency weakness. Contrary to economic theory, higher inflation prints can sometimes lead to short-term currency appreciation in…
Intro: High inflation is a common feature of emerging markets. Even when real GDP growth is positive and monetary and fiscal policies are prudent, the lack of willingness to hold local currency as a store of wealth typically results in higher inflation rates relative to developed markets. As explained in Strong Growth and Low Unemployment are…