For government institutions tasked with ‘officially’ collecting the numbers, let alone for people trying to buy their daily essentials, understanding and monitoring inflation is difficult. One ‘fallacy’ regarding inflation seeping through the gaps has been recognized by economists, but it’s actually a handy rule of thumb for common people.
The inflation fallacy is the mistaken belief that a rise in prices equals a loss in purchasing power. Many economists argue that every purchase represents the income of someone else, so this can’t be accurate. It is, nonetheless, a sensible rule of thumb for anyone living on a salary.
This mistake continues because it conceals an unpleasant truth about inflation. When we look at the economy as a whole, we can see that every dollar spent represents someone else’s income. This, however, falls short of understanding how inflation truly works in the real world. Unfortunately, the current structure of inflation has a significant impact on society’s winners and losers.
What exactly is the inflation fallacy?
The inflation fallacy is a fallacy that claims inflation is bad. Now and again, a false conclusion can emerge from an incorrect argument. Perhaps inflation is a bad thing. Perhaps inflation lowers our real incomes. However, it is still a fallacious argument. It provides no compelling evidence that inflation is harmful or affects our real incomes.
The inflation fallacy is often believed by non-economists. I’m an expert in non-economists’ perspectives on economics. That’s because I’ve been attempting to teach non-economists how to think about economics for the past 30 years.
“So, why is inflation a bad thing?” I’ll ask my ECON1000 students somewhere in February.
I can see their expressions coming. Some will give me that sympathetic look, which is usually reserved for folks who aren’t very bright. Others would assume this is a trick question, because I wouldn’t ask anything so clear. Finally, someone will respond.
“Because if all prices increase by 10%, we will only be able to afford to buy 10% less. Duh!” Except the “Duh!” is deafeningly quiet.
You could try to dispute the inflation myth by bringing up the concept of monetary neutrality. However, this is the incorrect method. Sure, if money is neutral and has no effect on real variables like real income, the inflation fallacy’s conclusion is wrong. That, however, is missing the point. The inflation fallacy is an error in logic. It is logically and philosophically perplexing. Even if the conclusion were correct, the argument would still be incorrect. Even if inflation did cause real incomes to decrease, the inflation fallacy would not be a good reason to believe that inflation would cause real incomes to fall.
Apples purchased must be equivalent to apples sold. What is an expense for the apple customer is a source of income for the apple vendor. The customer is $1 poorer and the seller is $1 richer for every $1 increase in the price of an apple. That holds true whether we buy and sell a single apple or a billion apples. Whether we include bananas, carrots, dates, or eggs, this is true. It holds true whether all prices increase by the same amount (or percentage), or by different amounts. It holds true whether we use money, gold, or venus dust to calculate pricing.
It’s just as reasonable to say that a 10% increase in pricing is a positive thing because it means we’ll earn 10% more money from selling goods and so be able to buy 10% more stuff. Let’s refer to this as the inflation fallacy number two. It is the polar opposite of the first inflation fallacy.
Why is it that the inflation fallacy mark 1 is so widely used, yet the inflation fallacy mark 2 is so uncommon? I’m not sure, but I’ll make some educated guesses.
1. We live in a specialisation and division of labor-based economy. We sell one item and purchase hundreds of others. Naturally, we know a lot more about the one product we offer than we do about the hundreds of products we buy. We are aware of the forces that influence the price of the one product we sell. We have no idea what forces affect the prices of the hundreds of items we purchase. So we coined the term “inflation” to describe our ignorance.
The term “inflation” refers to a rise in the cost of the items we buy. The cost of the product we sell is established in a unique method. As a result, if we think in this way, inflation will seem to make us worse off.
Inflation occurs when others raise their prices, not when I raise mine.
2. The majority of us get money by selling our labor. And we believe that others are similar to ourselves. We think of ourselves when we think of the representative person. The cost of labor has a unique term in our culture. We don’t refer to it as a “price,” but rather as a “wage.” And we conceive of inflation in terms of price increases rather than pay increases. We believe that inflation reduces real wages and makes people worse off since there is no evident one-to-one relationship between price and wage inflation, and we know that wages rise faster or slower than prices at times. Even if it did, we must remember that capitalists are also individuals. They are referred to as “the other.”
If apples were removed from the CPI and given a unique name, “inflation” would be defined as a rise in the price of bananas, carrots, and dates. As a result, we apple dealers are harmed by inflation.
The inflation fallacy is a logical error. It’s a compositional fallacy. It fails to recognize that the axiom “inflation is someone else’s price increase, not mine” does not hold true at the macro level, when all the buyers and sellers are added together. It’s a fallacy of someone who hasn’t encountered the accounting identity “revenue = spending.” It’s a fallacy of someone who doesn’t understand that production, not how much we pay each other, is the ultimate source of our collective income and expenditure.
It’s a fallacy I don’t think we’ll ever be able to get rid of. “Ours is an endless mission,” says the narrator once more.
I sympathize with those Austrians who define “inflation” as a rise in the money supply rather than a rise in prices. However, it is ineffective since both the demand for and supply of money can fluctuate. Even if you prevent them from using the term “inflation,” people will find another way to discuss rising costs. I also sympathize with Scott Sumner’s strategy of attempting to outlaw the usage of the “i-word” in favor of NGDP.
Because it’s a ridiculous question to ask, “Is inflation a good or negative thing?” It does not have a response. Inflation is a naturally occurring variable. It is dependent on the cause. If a harvest failure is the cause of inflation, we will be worse off. But it is not inflation that makes us poorer; it is the failure of the harvest. Our actual income is also reduced as a result of lower goods output. Inflation is merely a symptom of a larger problem. If we weren’t personally involved in the harvest, this is how a bad harvest will present itself to us.
The proper method to ask the question is to bring up the subject of monetary policy. Would the Bank of Canada’s 0 percent or 4 percent inflation targets make us better or worse off than the existing 2 percent inflation target? That’s when we may start debating the neutrality or non-neutrality of money, rather just accounting identities (strictly, super-neutrality of money).
It would also improve people’s minds if we could talk about the effects of a dropping value of money rather than a growing price of items. When we talk about the value of money declining, we’re implying that we’ll obtain more money for the items we sell and give up more money for the goods we buy. It leads us to consider both forms of the inflation fallacy mark 1 and mark 2 at the same time and observe how they balance each other out. Then, and only then, can we begin to consider the true issue.
Surprisingly, the existence of the inflation fallacy as a sociological phenomenon may be one of the greatest solid arguments against setting too high an inflation rate. The fact that so many regular people are perplexed by inflation suggests that it may be harmful.
What makes the inflation illusion so dangerous?
Because everyone’s spending is another person’s income, the inflation ‘fallacy’ is a fallacy. Inflation, on the other hand, is reducing the purchasing power of most wage and salary earners’ income and savings.
Which of the following is an example of inflation?
You aren’t imagining it if you think your dollar doesn’t go as far as it used to. The cause is inflation, which is defined as a continuous increase in prices and a gradual decrease in the purchasing power of your money over time.
Inflation may appear insignificant in the short term, but over years and decades, it can significantly reduce the purchase power of your investments. Here’s how to understand inflation and what you can do to protect your money’s worth.
What exactly is the case for inflation?
Economists claim that people’s expectations of inflation drive up prices because employees desire greater pay and businesses raise prices to protect themselves from it. In other words, people’s behavior is shaped by their thoughts. Political narratives, on the other hand, can alter these expectations.
What is the Fisher effect?
The Fisher Effect, coined by economist Irving Fisher, describes the relationship between inflation and both real and nominal interest rates. The real interest rate is equal to the nominal interest rate minus the predicted inflation rate, according to the Fisher Effect. As a result, unless nominal rates rise at the same rate as inflation, real interest rates fall as inflation rises.
Why is inflation so expensive?
Sustained inflation at a rate higher than Bernanke’s ideal long-run inflation rate can stifle economic growth through a variety of processes. One is the monetary cost of inflation, which comes as a result of inflation degrading the purchase power of money, resulting in increased costs for people and businesses to maintain their money balances. Many authors have claimed that such expenses are insignificant. However, Michael Dotsey and Peter Ireland design an example in which the combined impact of a number of modest expenditures is significant. 1 Other experts suggest that the costs of inflation appear low because standard models aren’t rich enough to capture all of the expenses. Otmar Issing, a member of the European Central Bank’s executive board and a former official of Germany’s central bank (the Bundesbank), has claimed that economists’ estimations of the costs of continuous inflation are shaky since they are dependent on model parameters. 2 As an example, he claims that inflation perplexes people and businesses as they try to separate changes in relative prices from changes in the overall price level and discern transitory from permanent price changesbut such costs are rarely included in models.
What is the inflationary cost of shoe leather?
In essence, shoe-leather expenses relate to the time and effort expended by people to reduce the impact of inflation on money’s deteriorating purchasing power. People, in order to maintain the worth of their assets, wear out their shoes on their walk back and forth to the bank.
What does inflation look like?
Inflation is defined as an increase in the price level of goods and services.
the products and services purchased by households It’s true.
The rate of change in those prices is calculated.
Prices usually rise over time, but they can also fall.
a fall (a situation called deflation).
The most well-known inflation indicator is the Consumer Price Index (CPI).
The Consumer Price Index (CPI) is a measure of inflation.
a change in the price of a basket of goods by a certain proportion
Households consume products and services.
In economics, how much does shoe leather cost?
In a metaphorical sense, the cost of shoe leather is the time and effort (or opportunity costs of time and effort) that people expend by holding less currency in order to lower the inflation tax they pay on cash holdings when inflation is high. These expenses include making multiple bank trips, not being able to make change, and being unable to make unexpected expenditures. The name stems from the fact that going to the bank and getting cash and spending it requires more walking (historically, though the introduction of the Internet has reduced this), thus wearing out shoes more quickly. The additional time and convenience that must be sacrificed to keep less money on hand than would be required if there were less or no inflation is a substantial cost of reducing money holdings.
In your own words, what is inflation?
Inflation is defined as a gradual increase in the prices of goods and services in the economy, accompanied by a reduction in the value of money. Learn how inflation works and how it impacts consumers, savers, and investors, as well as how it’s measured and how to tell the difference between inflation and deflation.