30
$\begingroup$

I’m not an economist and would like some insight into this thought experiment. If people, the news, social media, etc. suddenly stopped talking about inflation, would inflation still take place? Inflation is a money supply issue(?) so, if no one knows about the money supply, about how the government is printing and printing, as if the printing took place completely in the dark, would the price of goods still increase? What forces would drive this price increase? Thanks!

$\endgroup$
5
  • $\begingroup$ Why do you think inflation is a money supply issue? (obviously, they're usually tightly linked, but can you define one without reference to the other?) $\endgroup$
    – fectin
    Jan 3 at 16:36
  • 4
    $\begingroup$ The Edict on Maximum Prices was an attempt by the emperor Diocletian in 301 CE to reign in inflation without understanding what inflation was or why it caused prices to rise. $\endgroup$
    – chepner
    Jan 3 at 20:45
  • 5
    $\begingroup$ A nearby restaurant started to increase the price of every dish by one euro every year. They said it was "because of inflation". They didn't seem to realise they are the inflation, just like people stuck in a traffic jam don't realise they are the traffic jam. $\endgroup$ Jan 4 at 10:53
  • $\begingroup$ I asked a similar question a while ago and never really got a satisfactory answer; In a hyper-inflated economy, how do vendors know how much to raise their prices? $\endgroup$
    – Richard
    Jan 5 at 12:23
  • $\begingroup$ @GMoss: perhaps one can think of inflation as a domino effect phenomena. If one person for some reason is able to sell at higher price it sets off a reaction economy wide. The interesting part is that opposite doesn't happen with same force. $\endgroup$
    – Dayne
    Feb 21 at 9:23

8 Answers 8

44
$\begingroup$

In this case, I think it is best explained without any economics jargon.

If your thought experiment is taken to the extreme and no one knows about the money, it would literally imply that the money that was printed never went into circulation. In this scenario, nothing happens. However, usually someone doesn't print money just to store it in a vault or use it as wallpaper.

Let's assume the money is handed out to people (even if everyone thinks no one else got money). People have a tendency to spend their money to buy goods and services.

  • You can test that relatively quickly if you have kids, and you give them pocket money. Try to double it for some time. I would be very surprised if they would save everything. Seems in the UK, almost a quarter of children (22%) spend their pocket money immediately and, hence, do not save at all.
  • If you don't have kids, imagine you win a couple million in the lottery. What would you do with the money?

Now, a large scale increase in money supply is equivalent to everyone (at least whoever receives the money) "winning" the lottery. However, there is a problem. What you can buy in an economy is not determined by how much cash there is, but by the productive capacity (quality of factories and workers plus availability of raw materials). Let's assume people dream of a Tesla and finally (think they) can afford it with their newfound wealth. Unfortunately, Elon's company already finds it hard to build enough cars.

As soon as people try to spend the money, too many people are chasing too little goods and services. Even if companies wouldn't raise prices, they would run out of inventory. If companies would miss the opportunity to raise prices to a price where demand meets supply, you may think prices may not change after all. However, if people really want something and have money, they will try to get it somehow (e.g. offer the lucky ones who got a Tesla more money until they are willing to sell). Bottom line is that some will be willing to pay more, and others will be willing to sell for a higher price.

Eventually, if money supply grows very excessively indeed, people will realize money is so worthless that they will end up using it as wallpaper after all.

$\endgroup$
7
  • 13
    $\begingroup$ I'm reminded of the capitalist elements of Communist economies. Fixed prices, enough cash, not enough goods in the shops. The result were long waiting lines. $\endgroup$
    – o.m.
    Jan 3 at 6:36
  • $\begingroup$ Prices can also rise even if money supply doesn't increase at all? $\endgroup$
    – gerrit
    Jan 3 at 10:23
  • 1
    $\begingroup$ @gerrit, yes. Sticking to simplicity, assume that money is constant (as opposed to productive capacity above) but now allow for changes in the productive capacity; e.g. Tesla cannot get hold of computer chips and needs to produce less cars. Or an extreme example, assume there is no longer any oil from one day to another. There would be a lot of money chasing very little stuff. $\endgroup$
    – AKdemy
    Jan 3 at 10:36
  • $\begingroup$ @o.m. : those weren't "capitalist" elements. Capitalism means "free market", it's not a synonym for "bad". If the prices are fixed by the state, and the state controls all the supply, it's not a "capitalist element", it's the most basic example of the downsides of a planned economy. $\endgroup$
    – vsz
    Jan 3 at 12:13
  • 10
    $\begingroup$ @vsz Capitalism needs a free market, but the two are not synonymous. One can have a socialist free market economy; means of production are owned by non-profit worker-cooperatives competing in a free market. I do think o.m. misuses both the word capitalist (private ownership of the means of production) and communist (society with no money, state, or classes). The queues for consumer goods in the Soviet Union, socialised housing in many countries, or non-toll roads during rush hour in all countries, are a basic economic consequence of scarcity in planned economies. $\endgroup$
    – gerrit
    Jan 3 at 12:21
23
$\begingroup$

Yes and there is a real-world historical example.

Inflation is the term given to a natural phenomena where an overabundance of resources in human societies leads to the devaluation of such a resource and is applied especially to a resource used as a common medium of trade (money).

Long before the term inflation existed and long before (modern) economists existed the world saw its first inflation crisis. This is often called the Spanish Price Revolution.

The discovery of the Americas led to the discovery of gold and silver in the Americas which in turn led to the European powers, Spain in particular, to focus on mining gold and silver and ship them back to Europe. Back then there was a belief that gold and silver represent wealth (it wasn't until Adam Smith, arguably the first modern economist, that we changed focus from natural resources to human productivity as the measure of wealth).

The huge influx of gold and silver into Spain led to them being less rare and more common. This led to more and more people owning gold and thus depreciate the value of gold. Since gold and silver was used primarily as a medium of trade (to buy things with) the drop in the value of gold manifests itself as the increase of price of things you use gold to buy such as bread or beer - THIS IS BASICALLY INFLATION.

Nobody told the Spaniards their currency (gold) has been devalued. Nobody explained inflation to them. It just happened naturally from human behavior: if I keep selling out my products because everyone has lots of gold then why should I keep the prices of my products low when I know my customers have lots of gold?

Inflation is a theoretical tool but like almost all theories it is not a human invention. It is an explanation given to what we see happens in the real world.

$\endgroup$
2
  • 3
    $\begingroup$ Importing gold from the Americas is just like printing money where God is the printer and the Spaniards discovered God's warehouse of money. $\endgroup$
    – slebetman
    Jan 4 at 3:02
  • 1
    $\begingroup$ Nice example. Kipper and Wipper (Tipper and See-saw time) may also work as an example. $\endgroup$
    – AKdemy
    Jan 4 at 3:30
4
$\begingroup$

Indirect "knowing"

Explicit and direct publication of money supply information brings that information to the public quickly. However, in the absence of that, and with news social media not talking about that, indirect information about money supply spreads while the money supply is being used - trades being made, and the behavior of other participants in a market effectively does spread that information around. So the core assumption made by the original question "no one knows about the money supply" is plausible only if the increased money supply does not enter the economy/markets, as the activities in the market also disseminate information about supply and demand - that is pretty much a foundation of market economics.

Perhaps the most relevant analogies would be historical, looking at inflation in pre-modern economies before the concept of money supply was properly analyzed and understood (so people would not be talking about "money supply" directly, and social media and mass media did not exist yet), e.g. the influx of precious metals from Americas, the inflation cases driven by discovery of new ancient mines of precious metals, the pilgrimage of Mansa Musa might be an example, etc - and those are the big cases where the cause of increased money supply was so large and so obvious that we can clearly identify it after many centuries.

$\endgroup$
2
$\begingroup$

Yes inflation can occur even if people do not talk about it.

Inflation is positive growth in price level that can happen for multiple reasons.

Price level in the economy is determined by the money market. A simplistic model of money market you would find in 101 textbook is given by (see Blanchard et al Macroeconomics):

$$M/P = L(Y,i)\implies P=M/L(Y,i)$$

Where M is money supply, P price level Y real output and i interest rate. Also note that $L$ is money demand which varies positively with output and negatively with interest rate.

To get directly at inflation we can log-linearize the system and take time derivatives which gives us

$$ \frac{\dot{P}}{P} = \frac{\dot{M}}{M} - \frac{\dot{L}}{L}$$

Where $\frac{\dot{P}}{P} =\pi$ is the instantaneous growth rate of price level, i.e. inflation. So inflation will increase if money supply growth outpaces the growth of money demand (which hopefully makes intuitive sense).

Money supply and money demand are ultimately real factors. Money demand depends on output (e.g. this is how supply chain issues can affect inflation), but also on interest rates. In addition inflation also can be caused money supply increase (or combination of all of the above).

One thing that the 101 model above does not capture (but more advanced ones do) is that expectation of what the fundamentals are (e.g. output etc) matter as well. So talking about supply chain issues or other factors can affect inflation. But people do not form expectations just based on what they hear in media. Furthermore, ultimately real factors matter even if people have wrong expectations. If there are supply chain issues and a shop clerk sees that he always has shortage of wares natural response is to rise prices. Or if there is too much money in the economy because of expansion of money supply shop clerk will suddenly sees that people want to buy more and more of her products, she will rationally react to it by rising prices.

Thus while talking about inflation on TV can affect it somewhat (it can affect peoples expectations), inflation can take place whether someone talks about it or not. Ultimately, inflation depends on real economic fundamentals and its not like not talking about increase in money supply or not talking about changes to output or interest rates will somehow wish them away. If real output falls because maybe earthquake destroyed some important oil refinery that won't go away just by not talking about it. People might react more slowly when they are not able to get the news so their expectorations might be wrong for a while but eventually people will notice they cannot get gas at a pump and shopkeeper will notice that she does not have enough inventory to satisfy all the demand.

$\endgroup$
6
  • $\begingroup$ I appreciate seeing the math behind economics, which I know very little about. Thank you! $\endgroup$
    – GMoss
    Jan 3 at 2:45
  • $\begingroup$ Where does real estate enter this equation? Is a house that hasn't changed in any way except for its price "real output"? In many places, housing prices grow much faster than population growth, which means it can't be explained by an increase in demand alone? $\endgroup$
    – gerrit
    Jan 3 at 10:34
  • 1
    $\begingroup$ @gerrit real estate prices are not part of CPI, and thus housing price do not affect inflation; so I don’t understand where should it enter the question. $\endgroup$
    – 1muflon1
    Jan 3 at 11:14
  • $\begingroup$ @1muflon1 Is that a fundamental economic definition (housing prices not considered in inflation calculations) or a political decision to calculate it as such? $\endgroup$
    – gerrit
    Jan 3 at 12:37
  • 1
    $\begingroup$ @gerrit no it’s not political it’s because macro considers homes investments (eg like investing in stocks) not goods and services (although rent and user cost counts). Also inflation is aggregate phenomenon, people tend to talk about house prices inflation but that’s not really the inflation. Inflation occurs when aggregate prices rise, when 1 good or service price rises (house rent) but other prices fall (computer prices) they can offset each other so there is no inflation. Even if you would include housing in calculation of price level the formulas above would be unaffected $\endgroup$
    – 1muflon1
    Jan 3 at 12:44
2
$\begingroup$

The answer is yes. I agree with AKdemy's answer but I think it can be expressed more succinctly:

Shopkeepers/producers raise and lower prices for a whole variety of different reasons, in amongst these will be the rate of sale of their produce. So if products are flying off the shelves and the stock rooms are empty then this makes it more likely rational shopkeepers/producers will raise their prices whereas if products are scarcely selling and the stock levels are building up, this makes it more likely shopkeepers/producers will lower prices.

If new money is somehow sneakily given to people without any media reporting (perhaps people are given freshly printed money with a letter instructing them not to tell anyone about it and with no indication that anyone else is being given money in this way) then the recipients are likely to have a greater propensity to go out and buy stuff than they had before. This will lead to the aforementioned "flying off the shelves" scenario, leading to shopkeepers/producers raising prices.

$\endgroup$
2
$\begingroup$

While the other answers address the more traditional notion of inflation, there is in fact a type of inflation that can be countered by some sort of the proposed "stop-talking-about" strategy. It's called inertial inflation and it is basically the raising in prices due to people getting used to previous inflation.

The history behind Brazilian Real currency is considered the leading case of the concept. Real, a currency created to end Brazil's long fight against inflation, was initially launched in parallel with the former official currency (Cruzeiro Real or BRR), and companies were legally forced to display prices in both currencies. But no new bills were available to the public, so people still had to pay everything using BRR. The trick was that prices in Real were not allowed to increase. After a while, people got used to see stable prices in Real and only then the government printed new bills and retired BRR, effectively breaking the previous regime of "psychological" price increasing.

$\endgroup$
0
$\begingroup$

Suppose you have some good or service that multiple people want. You have been selling it for 10$ up until now, but you are selling out all of the time.

You are getting a new supply for this week, and someone offers you 15$ for it. They seem legit. Are you tempted?

Meanwhile, the stuff you need to make this good or service -- labor, food, equipment, etc -- you are finding harder to find at the old price point. Maybe you are selling eggs; but the price of grain to feed your chickens has gone up by 50% (people you used to buy grain for at 1\$ a bag are sold out, others are charging 1.5\$ a bag). If you, out of habit, keep selling your eggs at 10$ per cartload, you find you cannot afford to pay for the chicken food and your other costs.

So either you are finding it uneconomical to sell your eggs at the old price, or you are finding buyers willing to pay more, or both; this results in the price you charge for eggs going up, you getting poorer, or you going out of business.

You don't have to know why the price of your inputs is going up, nor why people are offering more money for your outputs, for you to make decisions that result in inflation.

You may complain this assumes inflation is occurring to prove it occurs. In most economic situations, people want more than they currently are getting. When there is more money in the system, they can buy more of the stuff they want if the price point remains unchanged.

So the influx of cash into the system (caused by whatever means) causes the demand for eggs to increase. More people want eggs. There are people who will only spend 10\$ on a cartload of eggs, but other people would be willing to pay more. They do so; and the 10\$ cartload of eggs gets sold out.

This increase in the demand of eggs causes some egg producers to decide to make more eggs. Making more eggs requires feeding chickens more or making more chickens, which requires more chicken food. So they start buying more chicken food.

This increase in the demand for chicken food (grain here) means that the supply of grain isn't enough. Some of the buyers are willing to pay more than 1\$ per bag; they are the ones that get it (because some grain sellers will prefer to sell it for more if they have a choice!), and the people only willing to spend 1\$ per bag end up having shortages (because more demand, no change in supply).

The grain sellers similarly realize that the price of bags of grain is up. So they will seek to increase their production; this means purchasing more inputs for grain (land, labourers, ships to carry it).

A demand "shockwave" travels through the economy.

If the economy had slack -- if it had a bunch of assets that where underutilized and cheap to bring online -- this can cause economic growth, which could actually lower prices (sometimes, making 10 cart loads of eggs is cheaper per cart load than making 3 cart loads of eggs). But if the economy does not have slack -- if matching the induced demand requires increasing costs (up to "cannot increase production"), prices will go up.

This relies on two things.

  1. If you give people money, they'll spend some of it.
  2. Spending money increases demand for stuff, which tends to increase prices for that same stuff in the short term.

Now, inflation expectations are another thing. What can happen is that people expect prices to go up year over year. When this happens, people plan for the increased prices of their inputs, and they arrange for contracts that bake in these increased expected costs in the prices they charge people.

So they'll make a deal with an egg buyer that they'll bring them an egg cart a week for 1$, but the price goes up by 10 cents every week, for the next 3 months.

Under this scenario, the prices go up even if there is no increase in input price for the egg seller. And the buyer now has inputs with known price increases, so they also arrange for their outputs to have known price increases in the future.

When an economy is full of such contracts, an increase in the money supply is baked into everyone's assumptions. If you stop increasing the money supply at the expected rate, instead of inflation calming down, you get irregular deflation and businesses collapsing. Even though there is plenty of money to lubricate the economy absent inflation, it acts as if you had a huge money supply crunch.

At least one country has gotten around this by issuing a special currency whose value against the other currency was auto-inflating. So you had the dollar and the super-dollar. The super-dollar was defined to be worth 1$ today, but increases in value by 20% per month against the dollar.

You could put up prices in super-dollars and accept dollars. You could even get bank accounts denominated in super-dollars, and salaries priced in super-dollars.

Initially described as an accounting trick, eventually people got used to just pricing everything in super-dollars and having to do math to convert dollars (how much is it this month?) when they buy stuff.

Once this happens, you start issuing super-dollar bills. And stop issuing dollar bills. And so long as you keep the money supply (in super-dollars) sane, the inflation expectations can go away.

$\endgroup$
0
$\begingroup$

Everyone is talking macro and like an educated economist. But I read this question as, if the idea of inflation and macro economics just disappeared from everyone's head, would inflation still happen... The answer is yes.

As a restaurant owner if the price of ingredients and supplies you need go up, you increase the price of your food to stay afloat and/or profitable. If the workers/government demand higher wages, you need to increase your price to stay afloat and/or profitable. You might even have a super fan who says they will pay you extra if you put some ingredients to the side just for him everyday, this might also make you consider raising the price.

As a maker of electronics if the raw materials of the copper/chips/whatnot go up, you need to increase the price to stay afloat and/or profitable. Or if you have scalpers selling to each other at double your selling price, that would also make you consider raising the price to the scalpers price, because why should you lose out on profit to instead profit the scalpers.

As the miner owner mining copper, say you have very little profit margin because of large fixed\unfixed overhead that you make up with sheer volume, if the government says you must lower production for the environment, your fixed overhead costs do not change and to make up for it you raise the price of your copper to stay afloat and/or profitable. Also, if because of the reduction of production the amount of copper available is low, you will have buyers trying to outbuy the other buyers so they can get more of your copper. Of course you would sell to that buyer.

This is all real world inflation, and without needing any sort of economics degree or fancy words or theories.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.