The rise and fall of global economics

By Melissa Luby, News Editor

Toilet paper in Zimbabwe costs over 400 Zimbabwean dollars per sheet. Drought conditions in Turkey have caused food prices to skyrocket, while prices in continental Europe are falling. These price changes reflect the causes and effects of inflation.

In the United States, citizens are more concerned with unemployment than inflation—but should they be? Esther George, president of the Kansas City Federal Reserve Bank, said in a recent speech that inflation is “the one thing the central bank must keep its eye on.” In light of the extreme cases of inflation occurring worldwide, Americans should keep an eye on it too.

In moderation, inflation is actually good for a nation’s economy. In fact, says Michael Strain of the Washington Post, the United States economy needs more inflation to reduce our unemployment rate—the economic statistic in which Americans are most interested. Decreased unemployment leads to higher, more competitive wages. Higher wages mean higher prices, and higher prices are the root of inflation.

Inflation, simply put, is an increase in the price of goods and services. For true inflation to occur, the prices of many types of goods, rather than just a handful, must be increasing.

There are two primary causes of inflation: an increase in the money supply, or an increase in prices of goods. According to Forbes columnist John T. Harvey, inflation usually starts when a corporation increases the price of one product. The result is a ripple effect: prices of related goods climb to balance increased production costs. This type of inflation is known as “cost-push” inflation.

Another type of inflation, as described on the Federal Reserve Bank of San Francisco’s website, is demand-pull inflation: corporations cannot produce enough of a product to meet demand, creating a shortage that makes prices rise.

Inflation is difficult to measure because of the numerous contributing factors involved. Economists have developed several methods to track the overall price levels of goods and services. According to the Federal Reserve Bank of Cleveland’s website, the three most prominent scales of inflation measurement are the Consumer Price Index, the Producer Price Index, and the GDP deflator. The Consumer Price Index, measured each year by the Bureau of Labor Statistics, tracks changes in price of a fixed set of goods that reflects a typical family’s purchases. The Producer Price Index uses the same set of goods, but records the profits made by the producer. The GDP deflator compares differences in the Gross Domestic Product from year-to-year.

George, in her Albuquerque speech, voiced her confidence in the American economy. “I don’t think inflation is at risk today,” she said. Although inflation is currently stable at 1.7%, American economic history has its share of bleak chapters.

From 1965 to 1982, America suffered what Jeremy Siegel described as “the greatest failure of American macroeconomic policy in the postwar period”—the Great Inflation. According to Michael Bryan of the Federal Reserve Bank of Atlanta, the 14-percent inflation rates of the 1980s were created by international demand for the US dollar, the costly programs of Johnson’s Great Society, and the Arab Oil embargo.

While 14% inflation rates may seem high, Zimbabwe battled an even greater economic crisis.

According to a 2006 New York Times report, inflation—or, rather, hyperinflation—in Zimbabwe was at nearly 1,000 percent per year, a figure normally only seen in war zones. Unemployment rates were estimated between 70 and 80 percent. The $500 bill was the smallest in circulation, and staples such as toilet paper, bread, and tea became luxuries. “If you have cash, you spend it today, because tomorrow it’s going to be worth 5% less,” said Mike Davies of the Combined Harare Resident’s Association in the New York Times article.

Zimbabwe’s government attempted to curb inflation by printing more currency—which is actually what caused the hyperinflation, which began in 2000. Eight years later, The Economist reports Zimbabwe has stabilized its economy by adopting the US dollar as its primary currency.
International demand for US currency was a key factor in the Great Inflation of the 1960s and 1970s.

Now, however, the United States is more at risk of deflation than inflation. From a consumer standpoint, deflation looks favorable—falling prices means more money to spend on luxury goods.

According to a Forbes report, however, what deflation actually causes is a false increase in the value of currency. Consumers stop purchasing in anticipation of lower prices in the future, resulting in falling demand, loss of jobs, and lower wages. If deflation persists, a recession occurs.

Evidence of deflation is all around us, from street corners to the stock market. Most Americans are aware of falling gas prices; fewer, however, are aware of the potential repercussions of these favorable-looking price changes. Increased oil reserves, cheaper and more plentiful energy sources, and less concern about depleting natural resources are causing not only a decrease in gas prices, says Economy Watch, but also in the price of gold.

Gold prices are as important to the economy as gas prices are to the consumer. Gold is perhaps the most important inflation hedge in the economy. Investopedia defines an inflation hedge as “an investment to provide protection against decreased value of currency.” A good inflation hedge maintains its value despite economic fluctuations. As inflation increases, more gold is needed to balance it. In the United States, however, Forbes reports the opposite is occurring: less demand for gold, resulting in prices below $1,200 per ounce.

Inflation rates in the United States are still growing modestly, but Europe is at severe risk for deflation. The Guardian reports European inflation rates are currently at just 0.3 percent.

Additionally, European interest rates are already at zero percent, which eliminates lowering interest rates as a possible means of battling deflation. The only—and less effective—option left for Europe is to print currency, which is exactly what Mario Draghi of the European

1 Comment

  1. Excellent explanation for those of us who have difficulty understanding these concepts! And very clear, concise writing, too, Melissa! Thanks for this piece.

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