I sketched earlier a brief description of how we got here.
Now I’ll attempt to offer an ‘alternative’ understanding of inflation. Not what it is – we all know that, but what it does.
It will be a functionalist view of the matter. Evolutionary, even.
As in ‘why do we still have inflation’. Why inflation continues to ‘survive’.
For most of our history, economy had been about solving needs.
Regardless of the market being momentarily free or not, for things to go on a balance had to be struck.
Demand had to be balanced by supply. Hence ‘price’.
Demand was mostly driven by the number of people needing something while supply was driven by the available natural resources AND by our ability to transform those resources into actual commodities.
For example, the price of wheat was influenced by the number of people living in a certain area, by the amount of arable land AND by the agricultural technology used at any given time. OK, the weather also had an impact but it was mitigated by the technology.
‘But how about imports? After all, ‘international’ grain trade is three millennia old. Ancient Athenian ships had been distributing ‘Ukrainian’ wheat all around the Aegean sea since before the Trojan war…’
Yeah, and how about emigration… the Irish had gone to America to escape famine, didn’t they?
We’ll get there. ‘Baby steps’, otherwise we may trip!
When population increased, they tried to add more arable land. If they could. If not – and/or in parallel, they tried to increase yield.
But the process was not linear. They could not ‘fine tune’ the increase of yield – by either method, exactly to the population growth. Hence the variation of price. Hence the ‘secondary mitigation measures’ – import/export and emigration.
‘OK, I understand. But prices can go both ways. Up AND down! Inflation only goes up…’
You’re speaking about individual prices. Which, indeed, go both ways.
And, yes again, inflation goes – in medium to longer time frames, only up!
You see, we have ‘price adjustments’ and (compounded) inflation.
Price adjustment is the mechanism through which the market – free or otherwise, balances the market for individual ‘items’. Encourages the consumption of wheat when the price is low and encourages the farmers to plant more wheat when the prices are high. Same thing for, say, shoe-shinning!
Meanwhile, (compounded) inflation is the mechanism through which the market – again, free or otherwise, balances itself.
‘Huh?!?’
For example, if wheat becomes too expensive, consumers (and suppliers) might decide to replace it with something else. Rice. Or potatoes.
Or, when grain prices become prohibitively low, farmers might abandon their plows and buy, say, shoe-shining tools.
‘But if rice – or anything else – would yield a lot more than wheat per the available arable land, the over all prices for food – and everything else, should go down, right? Not up…’
Well… in a rational world… maybe. That’s another long discussion.
The short version being that we usually wait for too long before making the necessary changes. Which is not necessarily wrong but that’s yet another long discussion. Only hindsight is 20/20…
Let’s say it would be possible to grow wheat and rice on the same plot of land without making any technological adjustments. If the growers would know what kind of weather would come in the next season, they would be able to plant the right crop. But they don’t. And it takes time for people to grasp the weather patterns have changed – and adjust the pertinent technology. On top of that, adjusting technology requires money.
Investment. Fresh ‘inputs’.
And who would do such a thing – plowing money into the ground, literally – without expecting an increased return? Something ‘extra’ for their effort?
In economic terms, nobody invests their money in a deflationary environment.
Why would anybody do such a thing?
Buy now when waiting till ‘tomorrow’ would make it possible to buy more for the same money?!?
That’s why inflation goes up. Period.
Cause otherwise the whole economy would become obsolete. We’d all be waiting for ‘tomorrow’.
NB.
This was a gross ‘simplification’.
A bare sketch.
Even in a deflationary environment, some prices do go up. For years overall prices have gone down – because of our increased technological prowess – while housing, education, healthcare and insurance have become more and more expensive. ‘Tilting’ the whole market.
More about this in the next post on the subject.
nicichiarasa 