Money Growth and Inflation

Although today you need a couple of dollars to buy yourself an ice cream cone, life was very different 70 years ago. In one Trenton, New Jersey, candy store (run, incidentally, by my grandmother in the 1930s), ice-cream cones came in two sizes. A cone with a small scoop of ice cream cost three cents. Hungry customers could buy a large scoop for a nickel.

You are probably not surprised at the increase in the price of ice cream.1 our economy, most prices tend to rise over time. This increase in the overall level of prices is called inflation. Earlier in the book,we examined how economists measure the inflation rate as the percentage change in the consumer price index (CPI), the GDP deflector, or some other index of the overall price level. These price indexes show that, over the past 70 years, prices have risen on average about 4 percent per year. Accumulated over so many years, a 4 percent annual inflation rate leads to a 16-fold increase in the price level.

Inflation may seem natural and inevitable to a person who grew up in the United States during the second half of the 20th century, but in fact, it is not inevitable at all. There were long periods in the 19th century during which most prices fell-a phenomenon called deflation. The average level o f prices in the U.S. economy was ’23 percent lower in 1896 than in 1880, and this deflation was a major r issue in the presidential election of 1896. Farmers, who had accumulated large debts, were suffering when the fall in crop prices reduced their incomes and thus their ability to payoff their debts. They advocated government policies to reverse the deflation.

Although inflation has been the norm in more recent history, there has been substantial variation in the rate at which prices rise. During the 1990s, prices rose at an average rate of about 2 percent per year. By contrast, in the 1970s, prices rose by 7 percent per year, which meant a doubling of the price level over the decade. The public often views such high rates of inflation as a major economic problem . In fact, when President Jimmy Carter ran for reelection in 1980, challenger Ronald Reagan pointed to  high inflation as one of the failures of Carter’s economic policy.

International data show an even broader range of inflation experiences. In 2005, while the U.S. inflation rate was about 3 percent, inflation was 12 percent in Russia and 15 percent in Venezuela. And even these After developing a theory of inflation, we turn to a related question: Why is inflation a problem? At first glance, the answer to this question may seem obvious: Inflation is a problem because people don’t like it. In the 1970s, when the United States experienced a relatively high rate of inflation, opinion pols placed inflation as the most important issue facing the nation. President Ford echoed this sentiment in 1974 when he called inflation public enemy number one.Ford Gerald wore a “WIN” button on his laps for Whip Inflation Now.

·But what, exactly, are the costs that inflation imposes on a society? The answer may surprise you. Identifying the various costs of inflation is not as straightforward as it first appears. As a result, although all economists decry hyperinflation, some economists argue that the costs of moderate inflation are not nearly as large as the general public believes lugger inflation rates are moderate by historical standards. In Germany after World , the price of paper rose from 0.3 marks in January 1921 to 70,000,000 marks less than two  later, with other prices rising by similar amounts. An extraordinarily high rate of inflation such as this is called hyperinflation.

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