How Does Inflation ACTUALLY Work? - YouTube

If you have a conversation with your grandparents about the price of anything, they’ll most

likely say something to the effect of, “When I was your age, I’d buy a bottle of Coke

for six cents!”, or perhaps, “I bought a house with a single entry-level job!”

And that seems to be the memory of lots of older people as they reminisce about their

youth.

It’s no secret that what a dollar can get you has changed significantly over time.

And these price changes aren’t exclusive to decades ago.

In January 2017, a whole chicken cost an average of $1.42 a pound, according to figures released

by the U.S. Department of Labor, Bureau of Statistics.

In January 2018, the price of that same chicken rose by nine cents, or 6.3 percent.

So what gives?

Why would the same exact thing cost more at a later time?

Inflation is the rate of an increase in prices for goods and services in an economy over

a set time period.

When the prices of goods rise, each unit of currency has less purchasing power than before,

so naturally, fewer goods can be attained.

Inflation in the United States is primarily tracked using the Consumer Price Index -- or

CPI -- a tool developed by the Bureau of Labor Statistics, which takes into account the pricing

data for thousands of goods across the country.

The BBC explained how the CPI helps us understand inflation and changing prices this way: “If

CPI is three percent, this means that, on average, the price of products and services

we buy is three percent higher than a year earlier.

Or, in other words, we would need to spend three percent more to buy the same things

we bought 12 months ago.”

Conversely, there’s what’s called deflation, which, as you guessed it, is when prices decrease

because there are more goods available than the amount of money circulating around to

buy them.

But not so fast!

While prices dropping sounds like a dream in Budget Land, deflation has been known to

increase the likelihood of a depression or a recession, so it’s also monitored closely

and stopped in its tracks.

The “why” behind inflation can be broken down into three reasons -- each of which will

shed light on specific types.

The first is when governments print more money.

Governments will often do this to stimulate the economy and create more jobs.

More money can be put into circulation by literally printing more of the physical money

or by increasing government debt.

A real-life example of inflation being caused by the printing of more money happened during

the Civil War era when the Confederacy printed $20 million worth of treasury notes.

To backtrack a bit, when the war started in 1861, one gold dollar cost one Confederate

dollar.

In just four months, the inflation rate rose to five percent, and that number became a

whopping 140 percent by 1863.

To give you a better idea of how high that was, inflation rates are typically two to

three percent every year in contemporary times.

What happened during this era, though, is an example of hyperinflation, or inflation

that’s increasing at an extremely high rate, although this example doesn’t come close

to what we’ll describe later.

Hang tight.

Another type of inflation is called cost-push inflation.

This is when the cost of maintaining a business rises and then customers have to then pay

more to help the business sustain itself.

The reason behind the rising cost of maintaining a business vary but are numerous -- sometimes

the cost of materials a business needs might increase, employees might be asking for higher

wages or land rents are getting higher.

The last cause of inflation we’ll mention is demand-pull inflation, or when the number

of people who want a good or service increases and supply isn’t increasing at the same

rate.

This sometimes happens when people are getting richer and therefore have more disposable

income.

Consumers could also find themselves with more to spend on goods and services when the

government cuts taxes, which could cause this type of inflation.

So, who are the key players behind making sure inflation doesn’t get too -- inflated?

These trusty masterminds can be found at the Federal Reserve, the United States’ central

bank who’s main purpose is controlling inflation and preventing a recession.

And the Reserve has a major say in the state of the nation’s smaller banks -- 80 percent

of the 6,000 banks around the country are part of a holding company, and this gives

the Reserve a peek into the financial standing of the country as a whole, according to the

Federal Reserve Bank of St. Louis’s website.

Several other countries have a central bank, too, like the Reserve Bank of India, the Bank

of England or the Swiss National Bank, to name a few.

A June 2019 article from TheBalance.com laid out the various ways the U.S.’s Federal

Reserve helps control inflation.

One is through the use of contractionary monetary policy, which enforces a reduction in government

spending—specifically deficit spending.

Governments enact deficit spending in the hopes of encouraging economic growth.

This spending would go towards medical supplies and buildings, for example, which would then

house businesses that’d hire people.

Contractionary monetary policy can also be implemented using what’s called open market

operations, or when the Reserve sells securities in the form of Treasury notes from member

banks.

When the Reserve sells these securities, banks are then forced to buy them, reducing their

capital and this gives banks less to lend out to people.

The final result of this is higher interest rates on loans.

The chain of events that make up open market operations help slow economic growth and keep

inflation on a tight leash.

Next, the Reserve can also raise the reserve requirement, or the amount of cash banks need

to have in their possession at the end of each day, which keeps money further out of

circulation.

The Reserve can also raise its discount rate, or the amount it charges banks to borrow money

in order to meet reserve requirements before closing each night.

Apart from contractionary monetary policy, the Reserve also manages inflation by limiting

the amount of credit allowed into the market by using liquidity, or the degree with which

money is available for investment or spending.

This would make it more costly for people to take out a loan.

Phew!

You get a huge pat on the back for following along with that jargon-filled economics lesson.

Ironically enough, the most important tool for controlling inflation -- according to

Ben Bernanke, former chairman of the Reserve -- has nothing to do with this policy.

He argued that it’s actually most important to make sure people don’t anticipate inflation

and then buy more of anything at a lower price, because that, in itself, can spur inflation.

He argued that it becomes a self-fulfilling prophecy in this way.

A cosmic theory when talking about something so concrete like money, huh?

We’ve painted a clear picture so far of how inflation works in the U.S., but hyperinflation,

when inflation rises by 50 percent or higher per month, has historically played out -- oftentimes

catastrophically -- across the globe.

Venezuela and its mammoth of an economic crisis will serve as our most recent example of this.

So far, the largest amount of inflation we’ve mentioned happened during the Civil War.

That pales in comparison to Venezuela’s situation -- the inflation rate increased

by 53,798,500 percent between April 2016 and 2019, according to Venezuela’s central bank.

The International Monetary Fund projected it would increase by 10 million percent by

the end of 2019.

We can use coffee to better explain what it’s been like for the Venezuelans in the midst

of this unrest: At the time of an August 2018 Forbes article about Venezuela’s hyperinflation,

the average price of a cup of coffee had risen to more than 2 million bolivars.

That’d come out to more than 10 U.S. dollars for just a single cup of joe.

You can probably relate to the feeling of spending a bit too much on coffee one morning,

but this is the norm for Venezuelans, not an outlier -- not to mention that the coffee

cost 1,400,000 bolivars a week before the article and 190,000 that April.

Venezuela’s hyperinflation is a symptom of a much larger and seemingly uncontrollable

economic problem, but it wasn’t always like this.

At one time, Venezuela, which was known for its fruitful oil reserves, boasted wealth

and stability.

When Hugo Chavez became president in 1999, oil prices went up and the government all

of a sudden had more spending money.

Then the labor strike at the oil company Petroleos de Venezuela, which lasted from December 2002

to February 2003, had serious economic repercussions -- gross domestic product, or the monetary

value of what a country produces -- fell 27 percent during the first couple months of

2003.

Chavez attempted to stop the decrease in the value of the bolivar, but it just led to more

problems.

A currency peg, import controls, subsidies for food and consumer goods -- all of which

happened after the strike -- set up a scenario for inevitable future inflation, according

to Forbes.

Fast forward to today, and Venezuelans are still largely dependent on the government

for goods and services, stores don’t have what people need and black market prices for

these items have increased.

And the situation continues to be bleak: According to the International Monetary Fund’s official

website, the inflation rate is currently at 500,000 at the onset of 2020 and the writing

of this script.

Almost 7,000 miles away, Zimbabwe presents another example of just how absurd and uncontrollable

inflation has historically played out.

Zimbabwe’s unrest can be traced back to the late 1990’s when land reforms were introduced,

some of which meant land was redistributed and went from white farmers to black ones.

They weren’t experienced enough to handle these new farms and thus weren’t able to

produce the amount of food necessary.

In the year 2000, Robert Mugabe, its president at the time, saw that his country was in economic

turmoil and people were starving on the streets.

The government mostly felt compelled to print more money because of the war with Congo that

was taking place at the time, and they needed more to pay the soldiers.

But other contributing factors included too much national debt and not enough output as

well as an overall lack of faith in the Zimbabwean government.

Back to Mugabe.

The obscene amounts of money weren’t getting invested properly, so there wasn’t enough

production of new goods, and the purchasing power of that money decreased.

The next eight years were hit by inflation to an astronomical degree, with results that

make it hard to believe this happened in real life.

By 2001, there was a 112 percent increase in prices per year.

By 2006, it’d skyrocketed to 1, 218 percent per year.

To give more numbers to explain this, inflation rose every day about 98 percent, so the price

of anything would double in a matter of 24 hours.

This all came to an end, thankfully, when Mugabe officially legalized transactions in

foreign currencies and the Zimbabwean currency was rendered nonexistent in 2008.

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