<p>Inflation is usually result of too much money chasing too little goods. Prices in economy adjust in such a way that effective money supply (money supply times velocity of money) will be equal to the number of transactions at current prices. The number of transactions is proportional to how much goods there are in economy. If there is more money chasing the same number of goods you will see inflation.</p>

CC BY-SA 4.0
2023-03-12T12:28:09.090Z
2023-03-12T12:28:09.090Z
Lorenzo Pozzi
<p>Just to make sure we are talking about the same thing, inflation is usually defined as a sustained increase in the <em>price level</em>, which is a composite index created out of goods and services.</p>
<p>To your points:</p>
<ol>
<li><em>We have that every year that more people are born (reduces labour price)</em>
<br> If the population grows, demand for things such as food, housing, clothing, haircuts, etc. probably also grows. Thus even if production is cheaper due to more labor where the new equilibrium lands is not clear. Though there are many &quot;truths&quot; espoused in econ 101, it is best to take these with a grain of salt, or at least pay very careful attention to the listed assumptions/caveats.</li>
<li><em>production is cheaper due to technology. This would mean that production would become cheaper with respect to time</em>
<br> Costs alone do not determine prices. For example, market power also plays a role; when there are less companies competing, their profit margins are usually greater. <br>
The global logistic chains also became stressed recently due to mid-term decisions during the early years of the pandemic (not well-modelled by econ 101, which mostly uses comparative statics), and this also increases costs/decreases supply.</li>
</ol>
<p>Bonus: <br>
Inflational phenomena are (IMO) not well understood, but it is usually agreed that expectations about future prices play a role. Suppose you want to lend money/make an investment, so that you can buy some goods/a house the next year. (Warning, this is a theoretical anecdote, a poor reasoning tool!) If you expect prices to increase by 1%, you would be willing to lend the money at a lower interest rate, than if you expected the prices to rise by 10%. Similarly, if you were looking to sell your house, but you expected housing prices to rise by 20% in the next year, you might put off selling your house by a year and take out a loan for now instead, as long as the interest rate was below 20%. Thus expectations about prices affect consumer/investment decisions, which may in turn affect future prices.</p>

CC BY-SA 4.0
2023-03-12T11:57:24.617Z
Pundits might not understand inflation but macroeconomists actually understand inflation well nowadays
csilvia
CC BY-SA 4.0
2023-03-12T13:25:19.647Z
I'm curious why you say that. I get the impression that inflation is rather ill understood.
Mick
CC BY-SA 4.0
2023-03-12T14:46:46.870Z
you likely have that impression because you just read news by pundits instead of actually reading published peer-reviewed literature in good journals or following courses from some serious universities. If you get all your info from pundits from fox news then even climate change looks like ill understood issue. Of course, real climate scientists have good understanding of climate change, but commentators that don't make it seem like climate science is not crystal clear, same with vaccines or inflation if you do not follow serious scientists it might look like ill understood issue
csilvia
CC BY-SA 4.0
2023-03-12T17:37:55.330Z
@csilvia Please [do elaborate here](https://economics.stackexchange.com/q/54703/1601)!
Giskard
CC BY-SA 4.0
2023-03-12T19:21:28.077Z
@csilva: I am getting my information from the words of senior central bankers, not pundits.
Mick
CC BY-SA 4.0
2023-03-12T20:00:05.820Z
@Giskard what is point in answering that kneejerk question? I agree with comments there that accuracy of forecasts is not a measure of understanding
csilvia
CC BY-SA 4.0
2023-03-12T20:03:20.353Z
@Mick no you are not, senior central bankers generally agree we understand inflation. In fact, Fed even has whole pages on explainers of how inflation works and what causes it. So you obviously do not base your information on what most central bankers believe. Maybe you base it on a cherry picked example of one or two central bankers from some not-well known central bank but that is equivalent to fox news cherry picking one study showing relationship between autism and vaccines and ignoring thousands studies debunking it.
csilvia
CC BY-SA 4.0
2023-03-12T20:08:28.200Z
I can't mute comments (at least I do not know how); if you want to continue this conversation please get a chat room.
Giskard
CC BY-SA 4.0
2023-03-12T08:50:14.713Z
2023-03-12T08:50:14.713Z
Giskard
<p>Inflation is logically possible because the spending of money is not limited to the amount of money that is earned. Spending can be greater than income, like when money is borrowed from banks. Things can be bought without first earning what is required to pay the price. People do this with houses, cars, furniture, overseas travel etc. They are financed with borrowed money, as long as the cost of borrowed money (the interest rate) is not too high.</p>
<p>Businesses use borrowed money to buy capital goods, and governments use borrowed money to finance budget deficits. If it wasn't for borrowed money, there would be much less economic activity, much slower economic growth, perhaps high unemployment, but no inflation.</p>
<p>Monetary policy is used to ensure that spending exceeds income. It is good for the economy. There is sustained economic growth and low unemployment. Inflation is an unfortunate side effect. Inflation is evidence that demand is greater than supply and the economy is growing.</p>

CC BY-SA 4.0
2023-03-12T09:22:39.547Z
2023-03-12T09:25:09.140Z
2023-03-12T09:25:09.140Z
Mark Munday
<ol>
<li><p>more people being born does not necessary mean that price of labor will fall. In fact in most countries you will see that wages (even adjusted for inflation) raise over time. Wages depend primarily on marginal product of labor, as people get more educated value of that marginal product increases.</p>
</li>
<li><p>Inflation is  typically not caused by items becoming more expensive to produce, although sometimes possible, that is quite rare. Inflation, is typically caused by <em>money</em> becoming less valuable over time.</p>
<p>Hence even if goods or services become cheaper (e.g. you need to work less hours to get them, they can be build with less time and resources), the price tag of these might increase because money itself lost value.  A money is just a numeraire good that is used to facilitate transaction. Value of money as of any good or service itself can fluctuate over time.</p>
<p>For example, price level (change of which leads to inflation and which can be considered inverse of price level), can be described via money market model (LM curve) as (see Blanchard Macroeconomics):</p>
</li>
</ol>
<p><span class="math-container">$$P=M/L(Y,i)$$</span></p>
<p>Where <span class="math-container">$M$</span> is money supply and and <span class="math-container">$L$</span> is money demand that depends on interest rate <span class="math-container">$i$</span> and real output <span class="math-container">$Y$</span>. If economy gets more productive (Y increases) prices do go down as money demand increases and if everything stays constant prices decline. However, changes in money supply or interest rate can have stronger effect than expansion in real output. In addition, something that is not captured by the simple textbook model above is that what matters is also expectations of future changes in <span class="math-container">$Y$</span>, <span class="math-container">$i$</span> and <span class="math-container">$M$</span>.</p>
<ol start="3">
<li><p>If you are talking about present inflation, especially food inflation, that there is nothing perplexing or mysterious about it. First, there was a supply chain issue caused by war and covid19 lockdowns   (see <a href="https://www2.deloitte.com/ch/en/pages/consumer-business/articles/covid19-has-broken-the-global-food-supply-chain.html" rel="nofollow noreferrer">this</a> and <a href="https://www.mckinsey.com/industries/agriculture/our-insights/a-reflection-on-global-food-security-challenges-amid-the-war-in-ukraine-and-the-early-impact-of-climate-change" rel="nofollow noreferrer">this</a> report by Deloitte and McKinsey respectively), and in addition there was also large expansion in money supply (data <a href="https://tradingeconomics.com/united-states/money-supply-m0" rel="nofollow noreferrer">here</a>) and interest rates were also kept at their lowest historical levels (data <a href="https://www.investing.com/economic-calendar/interest-rate-decision-168" rel="nofollow noreferrer">here</a>) until very recently (and even though interest rates increased and money supply declined very recently it takes time till price level is affected).</p>
<p>So, <span class="math-container">$M$</span> was up, <span class="math-container">$Y$</span> was down, <span class="math-container">$i$</span> was down. That is literally a textbook recipe for increase in <span class="math-container">$P$</span> (that is inflation), and by extension decrease in value of money (1/P). Hence, there is nothing that unusual about current inflation. Hence, not only it is logically possible its what you would expect following logic of even  basic textbook macro models.</p>
</li>
</ol>

CC BY-SA 4.0
2023-03-12T08:20:55.513Z
Your point 2 provides zero information.
Mick
CC BY-SA 4.0
2023-03-12T11:17:53.467Z
it obviously does by definition of information as it provides facts about inflation, rather your comment seems lacking in it
1muflon1
CC BY-SA 4.0
2023-03-12T13:22:25.700Z
I see you have now edited point 2 for the better, so my comment was worthwhile.
Mick
CC BY-SA 4.0
2023-03-11T23:15:26.793Z
2023-03-12T12:08:00.613Z
2023-03-12T12:08:00.613Z
1muflon1
<p>I am a total lay man on economics, but I find inflation to be an impossible phenomena. Here is my arguement for it,</p>
<p>We have that every year that more people are born (reduces labour price), and also that the means of production is cheaper due to technology. This would mean that production would become cheaper with respect to time.</p>
<p>However, we are finding that prices are rising day by day for even basic food stuffs in many countries. How on earth is this possible?</p>

<macroeconomics>
How is inflation logically possible?
Brian
# How is inflation logically possible?

(Asked by: username_0 on 2023-03-11)

I am a total lay man on economics, but I find inflation to be an impossible phenomena. Here is my arguement for it,

We have that every year that more people are born (reduces labour price), and also that the means of production is cheaper due to technology. This would mean that production would become cheaper with respect to time.

However, we are finding that prices are rising day by day for even basic food stuffs in many countries. How on earth is this possible?

**Tags:** macroeconomics


---

## 4 answers

### Answer by username_6 on 2023-03-11. Score: 5 | Accepted answer

1. more people being born does not necessary mean that price of labor will fall. In fact in most countries you will see that wages (even adjusted for inflation) raise over time. Wages depend primarily on marginal product of labor, as people get more educated value of that marginal product increases.
2. Inflation is typically not caused by items becoming more expensive to produce, although sometimes possible, that is quite rare. Inflation, is typically caused by *money* becoming less valuable over time.

   Hence even if goods or services become cheaper (e.g. you need to work less hours to get them, they can be build with less time and resources), the price tag of these might increase because money itself lost value. A money is just a numeraire good that is used to facilitate transaction. Value of money as of any good or service itself can fluctuate over time.

   For example, price level (change of which leads to inflation and which can be considered inverse of price level), can be described via money market model (LM curve) as (see Blanchard Macroeconomics):

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

Where $M$ is money supply and and $L$ is money demand that depends on interest rate $i$ and real output $Y$. If economy gets more productive (Y increases) prices do go down as money demand increases and if everything stays constant prices decline. However, changes in money supply or interest rate can have stronger effect than expansion in real output. In addition, something that is not captured by the simple textbook model above is that what matters is also expectations of future changes in $Y$, $i$ and $M$.

3. If you are talking about present inflation, especially food inflation, that there is nothing perplexing or mysterious about it. First, there was a supply chain issue caused by war and covid19 lockdowns (see [this](https://www2.deloitte.com/ch/en/pages/consumer-business/articles/covid19-has-broken-the-global-food-supply-chain.html) and [this](https://www.mckinsey.com/industries/agriculture/our-insights/a-reflection-on-global-food-security-challenges-amid-the-war-in-ukraine-and-the-early-impact-of-climate-change) report by Deloitte and McKinsey respectively), and in addition there was also large expansion in money supply (data [here](https://tradingeconomics.com/united-states/money-supply-m0)) and interest rates were also kept at their lowest historical levels (data [here](https://www.investing.com/economic-calendar/interest-rate-decision-168)) until very recently (and even though interest rates increased and money supply declined very recently it takes time till price level is affected).

   So, $M$ was up, $Y$ was down, $i$ was down. That is literally a textbook recipe for increase in $P$ (that is inflation), and by extension decrease in value of money (1/P). Hence, there is nothing that unusual about current inflation. Hence, not only it is logically possible its what you would expect following logic of even basic textbook macro models.

> **Comments:**
> **username_4**: Your point 2 provides zero information.  
> **username_6**: it obviously does by definition of information as it provides facts about inflation, rather your comment seems lacking in it  
> **username_4**: I see you have now edited point 2 for the better, so my comment was worthwhile.  

---

### Answer by username_1 on 2023-03-12. Score: 3

Inflation is usually result of too much money chasing too little goods. Prices in economy adjust in such a way that effective money supply (money supply times velocity of money) will be equal to the number of transactions at current prices. The number of transactions is proportional to how much goods there are in economy. If there is more money chasing the same number of goods you will see inflation.


---

### Answer by username_2 on 2023-03-12. Score: 0

Just to make sure we are talking about the same thing, inflation is usually defined as a sustained increase in the *price level*, which is a composite index created out of goods and services.

To your points:

1. *We have that every year that more people are born (reduces labour price)*
     
    If the population grows, demand for things such as food, housing, clothing, haircuts, etc. probably also grows. Thus even if production is cheaper due to more labor where the new equilibrium lands is not clear. Though there are many "truths" espoused in econ 101, it is best to take these with a grain of salt, or at least pay very careful attention to the listed assumptions/caveats.
2. *production is cheaper due to technology. This would mean that production would become cheaper with respect to time*
     
    Costs alone do not determine prices. For example, market power also plays a role; when there are less companies competing, their profit margins are usually greater.   
   The global logistic chains also became stressed recently due to mid-term decisions during the early years of the pandemic (not well-modelled by econ 101, which mostly uses comparative statics), and this also increases costs/decreases supply.

Bonus:   
Inflational phenomena are (IMO) not well understood, but it is usually agreed that expectations about future prices play a role. Suppose you want to lend money/make an investment, so that you can buy some goods/a house the next year. (Warning, this is a theoretical anecdote, a poor reasoning tool!) If you expect prices to increase by 1%, you would be willing to lend the money at a lower interest rate, than if you expected the prices to rise by 10%. Similarly, if you were looking to sell your house, but you expected housing prices to rise by 20% in the next year, you might put off selling your house by a year and take out a loan for now instead, as long as the interest rate was below 20%. Thus expectations about prices affect consumer/investment decisions, which may in turn affect future prices.

> **Comments:**
> **username_3**: Pundits might not understand inflation but macroeconomists actually understand inflation well nowadays  
> **username_4**: I'm curious why you say that. I get the impression that inflation is rather ill understood.  
> **username_3**: you likely have that impression because you just read news by pundits instead of actually reading published peer-reviewed literature in good journals or following courses from some serious universities. If you get all your info from pundits from fox news then even climate change looks like ill understood issue. Of course, real climate scientists have good understanding of climate change, but commentators that don't make it seem like climate science is not crystal clear, same with vaccines or inflation if you do not follow serious scientists it might look like ill understood issue  
> **username_2**: @username_3 Please [do elaborate here](https://economics.stackexchange.com/q/54703/1601)!  
> **username_4**: @csilva: I am getting my information from the words of senior central bankers, not pundits.  
> **username_3**: @username_2 what is point in answering that kneejerk question? I agree with comments there that accuracy of forecasts is not a measure of understanding  
> **username_3**: @username_4 no you are not, senior central bankers generally agree we understand inflation. In fact, Fed even has whole pages on explainers of how inflation works and what causes it. So you obviously do not base your information on what most central bankers believe. Maybe you base it on a cherry picked example of one or two central bankers from some not-well known central bank but that is equivalent to fox news cherry picking one study showing relationship between autism and vaccines and ignoring thousands studies debunking it.  
> **username_2**: I can't mute comments (at least I do not know how); if you want to continue this conversation please get a chat room.  

---

### Answer by username_5 on 2023-03-12. Score: 0

Inflation is logically possible because the spending of money is not limited to the amount of money that is earned. Spending can be greater than income, like when money is borrowed from banks. Things can be bought without first earning what is required to pay the price. People do this with houses, cars, furniture, overseas travel etc. They are financed with borrowed money, as long as the cost of borrowed money (the interest rate) is not too high.

Businesses use borrowed money to buy capital goods, and governments use borrowed money to finance budget deficits. If it wasn't for borrowed money, there would be much less economic activity, much slower economic growth, perhaps high unemployment, but no inflation.

Monetary policy is used to ensure that spending exceeds income. It is good for the economy. There is sustained economic growth and low unemployment. Inflation is an unfortunate side effect. Inflation is evidence that demand is greater than supply and the economy is growing.


---

