Friday, February 7, 2014

Inflation is not a boring topic. It is a thief in the night and the root cause of rebellion around the world. Can't get more exciting than that! See here why...

When I introduce the concept of  inflation in class I teach it from two angles. 

I tell students it is like a thief in the night.  It does not actually take money away from you but it makes the money in your pocket worth less (not to be confused with worthless) than it was worth yesterday.

Example:  A bottle of water costs $1.00 today.  I exchange one dollar for the water. Assume tomorrow the water is $2.00.  We certainly can say that the price has increased by a dollar, but I think it is more powerful and meaningful to say yesterdays dollar is worth half of what it was 24 hours earlier. I now have to give up two one dollar bills to get the bottle of water OR I can only buy half a bottle!

Another point I like to make is inflation creates social instability, especially for people in poorer, developing countries where a higher proportion of cash money is spent on "needs"---food, water, shelter, etc.

In many places where social instability or outright rebellion is happening if you rewind the events to the root cause it often started with rising prices on basic staples in the marketplace.

You can get students and other young people to protest in the streets for "democracy, freedom, etc" BUT you can get moms, dads and grandparents to join them if prices rise unexpectedly.  Movies are made about fights for freedom from oppression. Not so much about the real cause--loss of purchasing power due to inflation.

Do the research.  I think you will find this is true.  Look for it going forward.

Oh, wait, you don't have to!  Just read about this VERY THING here in the WSJ:
Inflation may lead to social unrest in developing countries because rising prices are especially painful for households that rely heavily on cash as a store of wealth, according to recent research from the Federal Reserve Bank of St. Louis. 
Yi Wen, an assistant vice president in the St. Louis Fed’s research division, wrote in a new working paper that in developing nations, “liquid money [cash and checking accounts] is the major form of household financial wealth and a vital tool of self-insurance [precautionary saving] to buffer idiosyncratic shocks because of the lack of the well-developed financial system.” 
Mr. Wen also noted “historical evidence” that “moderate inflation [around 10% to 20% a year] may be significant enough to cause widespread social and political unrest in developing countries.
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