Is inflation good, or is it bad?

Is inflation good, or is it bad?

To quote former U.S. Federal Reserve Chairman Paul Volcker, “Yes.”

If that seems unclear, it’s because, like much of economics, no cut-and-dried answer applies in all situations.

Whether inflation is good or bad depends very much on who’s being asked, and what that person’s economic situation is.

Some schools of economic thought, such as the predominant Keynesians, argue that inflation, defined as “a sustained increase in the general level of prices for goods and services in a country,” is a natural result of the changing ratios of supply and demand.

Keynesians also think that inflation has a net benefit at moderate levels.

Other schools of thought, namely the Monetarists and the Austrians, define inflation more tightly as “a general increase in the money supply.”

Either way, it leads to the same general effect.

With inflation, the prices of goods and services throughout an economy increase, and the relative value of the money itself decreases.

 

Inflation is Bad! No, Wait… It’s Good!

Inflation

The Austrian school economists, in particular, pointed to inflation as being a matter of government policy, not an “act of God” that was unaffected by human decisions.

Some go further and take the ideological position that inflation is a form of theft on the part of governments, because by decreasing the value of money it erodes the value of cash savings.

Anyone keeping cash in a bank savings account during inflationary conditions will see the purchasing power of that cash steadily diminish over time.

That is unless the bank can offer them an interest rate equal to or higher than the inflation rate.

The effect is similar on people who receive fixed incomes.

If there is inflation, and these incomes are not periodically adjusted to match the inflation rate, the purchasing power of that income continually reduces.

But what if a person carries a large amount of debt?

In that case, inflation is nothing short of a godsend.

In fact, the higher the rate of inflation, the better it is for debtors.

Since debts are almost always in terms of fixed amounts of money, plus interest, it helps debtors when the value of that money decreases relative to other prices in the economy.

Under inflation, wages tend to rise along with increased prices for goods and services, since businesses can afford to pay more when their income increases.

If wages rise, but debts retain their value, they are easier to pay off.

 

Is inflation just what it is?

Inflation of a hot air ballon

Naturally, creditors don’t want high rates of inflation because they don’t want to be paid back with something less valuable than what they originally loaned out.

This brings us back to the question of whether this is a form of theft.

The way around that is to charge increasingly high interest on debts, but that’s beside the point.

It can be clearly seen here that inflation in the context of a single economic transaction is often advantageous for one participant and disadvantageous for the other.

That being said, it’s possible for each participant to simultaneously experience both positive and negative effects from inflation.

In the Canadian small business context, given the significant inflation in housing costs in multiple Canadian cities in recent years, landlords are enjoying significantly higher rental incomes.

That means these business owners can then spend in other areas of the economy, whereas renters themselves may be increasingly cash-strapped.

Discount stores will tend to do better than higher-end retail in areas with many renters due to inflation.

Numerous other factors are at play, but clearly inflation changes economic calculations.

Small businesses have multiple financial considerations.

Numerous expenses and sources of income, debts carried and consumer prices all come into play here.

Inflation increases property values, so taxes will be higher.

Inflation also increase the value of the goods being sold, so receipts would go up as well.

Higher income means the business can expand in any number of ways, by increasing employee pay, hiring more employees or investing in more capital goods.

The prices of all those goods and services may also be higher, too.

However, natural population increases tend to lead to higher demand along with an increased labor supply over time.

That’s one reason why governments and central banks attempt to control inflation at a low percentage, around 2 to 2.5 percent, while allowing for moderate economic expansion.

Where this gets dicey is in the fact that inflation is never constant, and can also run out of control by financial authorities.

 

Hyperinflation

Venezuelan Money

Inflation has the effect of encouraging spending, and discouraging saving.

If the money will be worth less tomorrow, it’s better to spend it today.

Unfortunately, the end result of that behavior is… running out of money.

Throughout history, a number of countries have experienced what is known as hyperinflation, where inflation rises faster than 50 percent per month.

Desperate or incompetent governments have turned to it as a last resort to avoid credit default.

By rapidly increasing the money supply, they can erase their national debts.

However, the currency becomes nearly worthless in a very short time, which is a disaster for everyone.

It has the effect of superheating an economy.

Savings are eliminated, and workers have to spend their money as soon as possible after receiving it before its value, too, is destroyed.

The economic dislocation caused by hyperinflation in Germany in the 1920s is an unfortunate example of hyperinflation.

The country tried to frantically pay off the reparations imposed on it after World War I, but printing so many deutsche marks led directly to such intense political dissatisfaction that Germans voted Adolf Hitler into power.

The currency was so worthless and so numerous, people found it worked better as fireplace fuel as opposed to spending them at the local market on food.

The southern African country of Zimbabwe experienced hyperinflation around 2007 and 2008, following severe economic mismanagement by its government.

A land reform in the 1990s caused agricultural and industrial output to plummet.

Alongside a large amount of war spending, the only way the government could keep the country from starving to death while attempting to meet its debt obligations was to print more and more cash.

Hyperinflation peaked at nearly 80 billion percent per month in late 2008, after which the Zimbabwean dollar simply ceased to be accepted by anyone as a valid form of currency.

Zimbabwe now uses the currencies of the United States, the European Union and a few other countries in its place.

Modern-day Venezuela is experiencing a similar crisis.

The government’s main source of income is petroleum royalties.

For a number of reasons, including an oil price collapse, those revenues dried up.

The Venezuelan government had to resort to hyperinflation just to keep basic utility services functional in the country.

Even then, there’s not enough to keep the lights on.

It may very well end up destroying the current government.

 

Is inflation good or bad for Canadian businesses?

 

 

Well, at the moment Canada is at a turning point.

While Bank of Canada governor, Stephen Poloz, seems to be pessimistic about the future of the Canadian economy, the latest jobs figures seem to suggest that things are moving in the right direction.

In fact, the jobs figures suggest that businesses will soon start having to raise wages to get the best staff in what is becoming a more competitive job market. This in turn will lead to more disposable income and more revenue for Canadian businesses.

It would seem to be a good time to be a small business in Canada.