Is human psychology really reflected into inflation?

Question

I am a total noob in economics, but I'm trying to understand why do we have inflation. I can see that prices are increasing over time and, by definition, this means inflation. I'm fine with this definition, but I don't understand why we have it everywhere in the world.

Once, someone told me that this is caused by our psychology and that we kind of "get used" to something, and it doesn't have the same value like before, and I was wondering if this is right. Do money depreciate because we give it a less value over time or what is the fundamental reason for inflation? Or is it more complicated than my kindergarten understanding of it?

I can imagine that this is a stupid question for most people, but for me, it is very important to understand it at the fundamental level.

Answer 1

Economics is, first and foremost, a discipline that tries to understand human behavior, in particular human behavior regarding scarce resources and choices over them. You are correct in doubting a "we kind of get used to it" explanation if you want an economic explanation. While people may give a lot of reasons to why they make prices behave the way they do, empirically they behave as acting upon the laws below.

Inflation has been plaguing humanity since it developed coinage (barter and money-less economies can't have inflation) and many theories have been developed to explain it. Causes at a fundamental level have changed as economic theories came and went, but there's a consensus among most modern economists.

Without going too much into details, money itself is a good, and as such it's influenced by basic laws of supply and demand. If people desire more money to spend on goods, its value will go up (and the price of things in term of money will go down); if people desire less money, its value will go down (and the price of things in terms of money will go up). In the long term, inflation is a purely monetary phenomenon: more/less money around means more/less supply and more/less goods around to spend money on mean more/less money demand. In the short term, other effects dominate, such as:

• If people expect prices to go up, for whatever reasons, they'll mark up prices in a self-fulfilling prophecy. That's why part of a central bank's job is aligning expectations.
• Certain prices, like wages, don't update frequently (especially if they ought to go down to reach equilibrium). This is one of the main reasons most central banks strive to reach a ~2% inflation rate: instead of getting wages down by increasing unemployment, they lower wages to equilibrium across the board.
• There can be a spiral were firms raise prices and workers demand higher wages to pay for those prices, and firms need to rise prices to pay for wages...
• Around Christmas, people buy more. Central banks know this and put more money on the market to account for this extra demand.
• What constitutes money is a hard question to answer, but in general it depends on how easy it is to buy goods with it. More money that no one spends won't imply more supply. This means you can print all the money you want and have no extra inflation... if you don't spend it.
• If there's a systemic effect, like higher gas prices or exchange rates, a lot of prices will go up to align with lower purchasing power for a country. This is why central bankers tend to focus on "core" inflation instead of actual inflation.

You can see that it has a quite complex dynamics, but I hope the above will give you an intuition behind how to think about inflation.